Reserve accumulation can be inflationary, ECB paper says

An increase in international reserves can be inflationary, according to a working paper published by the European Central Bank (ECB) today (January 25).

In Reserve accumulation, inflation and moral hazard: Evidence from a natural experiment, Livia Chițu says inflation could stem from the "imperfect" sterilisation of the increase in reserve holdings, or the moral hazard that emerges as public authorities "become more complacent" in the face of their "perceived safety".

To separate out the two channels, the author examines the general allocation of special drawing rights (SDRs) in 2009, involving all 186 member countries of the International Monetary Fund. This is the only way of increasing a country's reserves without impacting the monetary base, the author notes, allowing the paper to focus on the moral hazard channel.

The paper splits the countries into two groups – large and small – depending on whether the SDR allocation accounted for more than 10% of its international reserves. "Inflation in countries receiving large SDR allocations was about half a percentage point higher in annual terms within the next two years following the allocation," the author says.