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Cover -- Contents -- 1 Introduction -- 2 A model of optimal reserves management -- 2.1 Model structure -- 2.2 Carry cost and the target level of reserves -- 3 Calibration -- 4 Quantitative Results -- 4.1 Target and average levels of reserves -- 4.2 Impulse response functions -- 4.3 Linear rules -- 5 Conclusion -- 6 Appendix: Certainty Equivalence

There has been a lot of interest since the global financial crisis in policies allowing emerging market economies to smooth the effects of the global financial cycle. Although the literature has focused mostly on capital controls emerging market governments have relied mostly on international reserves management. This paper discusses the role of reserves in capital flow management based on a simple welfare-based model of capital flows with international banking frictions.

There is a wide variety in the capital account policies of emerging markets and developing economies. Some countries, such as Brazil, have recently experimented with prudential controls on capital inflows, whereas others, such as China, have continued to maintain tight controls. This paper reviews the recent theoretical literature explaining the motivations behind capital account policies, and whether there is a case for international coordination in this area.