IMES DISCUSSION PAPER SERIES

Reserve Requirement Policy over the Business Cycle

Pablo Federico, Carlos A. Vegh, and Guillermo Vuletin
Discussion Paper No. 2014-E-6

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IMES Discussion Paper Series 2014-E-6
August 2014

Reserve Requirement Policy over the Business Cycle
Pablo Federico*, Carlos A. Vegh**, and Guillermo Vuletin***
Abstract
Based on a novel quarterly dataset for 52 countries for the period 1970-2011, we
analyze the use and cyclical properties of reserve requirements (RR) as a
macroeconomic stabilization tool and whether RR policy substitutes orcomplements monetary policy. We find that (i) around two thirds of developing
countries have used RR policy as a macroeconomic stabilization tool compared tojust one third of industrial countries (and no industrial country since 2004); (ii)most developing countries that rely on RR use them countercyclically; and (iii) in
many developing countries, monetary policy is procyclical and hence RR policy
has substituted monetary policy as a countercyclical tool. We interpret the latter
finding as reflecting the need of many emerging markets to raise interest rates inbad times to defend the currency and not raise or lower the interest rate in goodtimes to prevent further currency appreciation. Under these circumstances, RR
policy provides a second instrument that substitutes for monetary policy. Evidence
from expanded Taylor rules (i.e., Taylor rules that include a nominal exchange rate
target) supports these mechanisms.
Keywords: macroprudential; reserve requirement; monetary policy; exchange rate;business cycle
JEL classification: E32, E50, F31, F41*BlackRock (E-mail:pablo.federico@blackrock.com)**Johns Hopkins University and NBER (E-mail: cvegh1@jhu.edu)***The Brookings Institution (E-mail:gvuletin@brookings.edu)
The first draft of this paper was written while the authors were visiting the World Bank’s
Office of the Chief Economist for Latin America and the Caribbean (LAC) and Vegh was also
visiting the Macroeconomics and Growth Division (DEC) at the World Bank, and is part of a
project on macroprudential policy carried out at the Office of the Chief Economist for LAC.
The authors are very grateful for the World Bank’s hospitality and stimulating policy andresearch environment. They would also like to thank Enrique Alberola, Stijn Claessens, Tito
Cordella, Augusto de la Torre, Eva Gutierrez, Luis Jacome, Alain Ize, Michael Leahy, Samuel
Pienknagura, Andy Powell, Alessandro Rebucci, and seminar participants at the Bank of Japan,
Bank of Spain, Brookings Institution, CEMLA, Central Bank of Bolivia, Central Bank of
Uruguay, IDB, IMF, and World Bank for many helpful comments and discussions. Jorge Puig
and Pedro Pablo Matinez provided excellent research assistance. The views expressed in thispaper are those of the authors and do not necessarily reflect the official views of the Office of
the Chief Economist for LAC, the World Bank, or the Bank of Japan.

1Introduction

The recent global …nancial crisis has triggered an intense debate on the pros and cons ofusing macroprudential policy, broadly de…ned as the use of prudential tools, such as reserveor capital requirements, for macroeconomic stabilization purposes. Although the discussion
is certainly not novel –many emerging countries had resorted to macroprudential policy wellbefore Lehman Brothers’demise on September 15, 2008 –it took an urgent undertone in lightof the sudden realization of the severe contractionary forces that could be unleashed by theabrupt unwinding of …nancial imbalances and systemic risk.
Perhaps one of best examples of the renewed debate on macroprudential policy is theresurgence of the so-called “Tobin tax”–a …nancial tax on short-term capital in‡ows –whose
popularity had arguably reached a low point by the middle 2000’s, after gaining some limited
popularity in previous decades thanks to its use by Chile.1 The mere fact that even the IMF–presumably a bulwark of macroeconomic orthodoxy –has come out in favor of using Tobintaxes under some circumstances is a dramatic illustration of the search for new policy tools
in this much-changed post-Lehman world.2
There are, of course, many prudential tools that can be used for macroeconomic stabilization purposes, including reserve requirements, capital requirements, caps on the loan-to-value
ratio, credit ceilings, and dynamic provisioning, among many others. Broadly speaking, thepurpose of using these instruments is to reduce the amplitude of the …nancial cycle and containpotential …nancial vulnerabilities that could be created as a result. Whether many of these
instruments should be used at all and how e¤ective they may be is the subject of an emerging
literature. For example, based on data from an IMF survey, Claessens and Ghosh (2013) lookat seven di¤erent prudential instruments and conclude that debt-to-income caps, limits on
foreign currency lending, and loan-to-value ratios have been relatively e¤ective in reducing
vulnerabilities in banking systems. In a similar vein, Lim et al. (2011) present some empirical1
2

See Edwards, De Gregorio, and Valdes (2000).
See IMF (2012).

2

evidence to the e¤ect that macroprudential policy may be e¤ective in reducing procyclicalityof …nancial variables and reducing systemic risk.3 By and large, however, the e¤ectiveness ofmacroprudential policy is still very much an open question.
This paper contributes to the empirical discussion on macroprudential policy by focusing
on a particular instrument (reserve requirements).4 Due to data limitations, existing studies
on the e¤ectiveness of reserve requirements (see, for instance, Tovar et al. 2012) focus on the
recent past and a small group of countries. There is simple no readily-available, panel data on
reserve requirements. To remedy this situation, we build from scratch a novel quarterly dataset
on legal reserve requirements for 52 countries, 15 industrial and 37 developing, for the period
1970-2011.5

We focus on legal (as opposed to actual) reserve requirements because legal

reserve requirements are a policy instrument whereas actual reserve requirements constitutean endogenous outcome that will be a¤ected by the amount of deposits (i.e., the state of thebusiness cycle)6 7 We believe that gathering such large dataset is a fruitful endeavor because
it will allow us to characterize the use of reserve requirements over the business cycle drawing
on a very heterogenous dataset covering up to four decades and very diverse countries andmacroeconomic circumstances.
With this dataset in hand, we ask the following questions: (i) what countries have usedreserve requirements as a macroeconomic stabilization tool? (ii) How does the use of reserve
requirement policy as a macroeconomic stabilization tool compare in emerging and industrial
countries?

(iii) In countries that actively use reserve requirements, have they been used3

See also Borio and Shim (2007), Calderon and Serven (2011), Canuto and Ghosh (2013), De la Torre, Ize,
and Schmukler (2012), IMF (2011), Glocker and Towbin (2012), Montoro and Moreno (2011), and Vargas etal. (2010).
4
We choose to focus on reserve requirements because (i) they are arguably the most popular macroprudential
tool, and (ii) by its very nature (a long history and available time series from Central Banks and other domestic
sources), it is feasible to gather a large panel dataset.
5
As will become clear from our analysis, the quarterly (as opposed to annual) frequency is critical when it
comes to assessing the cyclical properties of reserve requirements policy.
6
Using reserve requirements as a ratio of deposits would not solve the problem because changes in deposits
would change such an e¤ective reserve requirement rate without a change in policy, as would voluntary changes
in reserves on the part of the banks.
7
Hence, in what follows (and unless stated otherwise), the expression “reserve requirements” should betaken to refer to the legal reserve requirement rate and “reserve requirement policy” to changes in such a rate.

3

countercyclically? (iv) Has reserve requirements policy (henceforth RRP) acted as a substitutefor or complement to monetary policy?
To answer these questions, we …rst compute the frequency of change in reserve requirements. Unlike standard economic time-series (like, say, government spending) which vary
continuously over time, reserve requirements may stay constant for prolonged periods of time(i.e., they behave more like a tax rate or the price of a single good). In the case of Chile, forinstance, legal reserve requirements have changed only twice in our 31-year sample. We takethe frequency of changes as a potential indicator of whether reserve requirements are used for
macroeconomic stabilization purposes.8

In particular, if reserve requirements are changed

more than once over the business cycle, we conclude that countries make active use of RRP.9
Based on this indicator, we divide our sample of 52 countries into “active” versus “passive”
countries when it comes to RRP. We conclude that 62 percent of the countries in our sample
have pursued an active RRP. This …gure, however, masks a big di¤erence between emerging
markets and industrial countries: 2/3 of developing countries have been active compared tojust 1/3 of industrial countries (and no industrial country since 2004). Indeed, almost halfof industrial countries have zero reserve requirements (i.e., no legal reserve requirements)
We then compute the cyclical properties of RRP for the active group of countries and …ndthat 70 percent have pursued countercyclical RRP. This …gure increases to 90 percent since2004. The fact that so many developing countries have used RRP as a countercyclical tool
is nothing short of remarkable in light of the fact that only little more than half of developing countries have engaged in countercyclical monetary policy (compared to 100 percent
of industrial countries).

We attribute the asymmetric use of RRP and monetary policy in

8Naturally, it could be the case that reserve requirements are changed frequently for, say, microprudential
reasons, but this is unlikely.
9The “obvious” alternative would be to compute the correlation between the cyclical components of thelegal reserve requirement rate and the business cycle (i.e., GDP) and de…ne as active countries those for which
the correlation is signi…cantly di¤erent from zero. However, while computing correlations makes sense forstudying the cyclical properties of …scal or interest rate policy (see, for instance, Frankel, Vegh, and Vuletin(2013) and Vegh and Vuletin (2012)), it would make little sense for reserve requirements because while one canmechanically compute a “cyclical” component for a series that has changed only twice in 31 years, it would be
devoided of economic meaning.

4

developing countries to what we refer to as the “fear of free falling” (in bad times) and “fearof capital in‡ows” (in good times). “Fear of free falling” refers to the reluctance of emerging
markets to lower interest rates in bad times to help the economy get out of the recession forfear of facing rapid currency depreciation.

As a result, policymakers may choose to lower

reserve requirements to help the economy get out of the recession. In a similar vein, “fearof capital in‡ows”captures the idea that, during good times, the monetary authority may bereluctant to increase interest rates for fear of attracting more capital in‡ows, in which caseit may choose to increase reserve requirements to cool down the economy.

In such cases,

RRP acts as a substitute for monetary policy in the sense that, in bad (good) times, reserve
requirements do what monetary policy cannot do; that is, spur (cool down) the economy. In
contrast, when both RRP and monetary policy are countercyclical, we say that they act ascomplements because they both pursue the same goal (i.e., reactivating the economy in bad
times and cooling it down in good times).
To capture the complementarity/substitutability between monetary policy and RRP, we…rst construct a 3x3 “policy mix matrix” that combines the cyclical stance of RRP andmonetary policy (procyclical, acyclical, and countercyclical). The typical industrial country
is acyclical when it comes to RRP and countercyclical in monetary policy. Indeed, as alreadymentioned, most industrial countries rarely change reserve requirements. The most common
policy mix for emerging markets is acyclical monetary policy (re‡ecting, in our interpretation
fear of free falling/capital in‡ows) and countercyclical RRP. We also con…rm this stylized fact
and the above suggested mechanisms using expanded Taylor rules, which include an exchange
rate gap, in addition to output and in‡ation gaps (as traditional Taylor rules).10 Analyzing
the behavior of both monetary and reserve requirements policy, we …nd that for countries
that use reserve requirements actively, RRP is countercyclical.

In contrast, interest rate

policy does not respond systematically to output ‡uctuations (i.e., is acyclical) but increases(decreases) when the currency tends to depreciate (appreciate). On the other hand, countries
10

See, for example, Corbo (2000) and Moron and Winkelried (2005).

5

that make no active use of reserve requirements respond countercyclically with interest rates
and positively to the in‡ation and exchange rate gaps.
The paper proceeds as follows. Section 2 introduces the reserve requirements dataset anddiscusses three basic features. First, it describes four di¤erent arrangements depending onwhether reserve requirements vary according to maturity and/or currency. Second, it identi…es some historical trends on the evolution and dispersion of reserve requirements over time.
Lastly, it analyzes the relationship between the cyclical components of di¤erent reserve requirements in countries which have multiple reserve requirements. The evidence points out
to the presence of a common RRP even in the presence of multiple reserve requirements. Section 3 develops the main analysis on macroprudential policy over the business cycle. Section
4 studies the complementarity/substitutability between RRP and monetary policy. Section 5
reinforces the …ndings of Sections 3 and 4 using expanded Taylor rules. It also provides formal evidence regarding the importance of the fear of free falling and capital in‡ows channels
described above. Section 6 concludes.

2

Reserve requirement data

The database originally collected for this paper is part of a World Bank regional study on
macroprudential policy carried out by the O¢ ce of the Chief Economist for Latin America.
The database comprises 52 countries, 15 industrial and 37 developing countries: Argentina,
Australia, Belarus, Brazil, Canada, Chile, China, Colombia, Costa Rica, Croatia, Czech Rep.,
Denmark, Dominican Rep., Ecuador (dollarization), Ecuador (pre-dollarization), El Salvador,
Euro-17, France, Germany, Guatemala, Honduras, Hungary, India, Israel, Jamaica, Japan,
Latvia, Lithuania, Macedonia, Malaysia, Mexico, New Zealand, Nicaragua, Norway, Panama,
Peru, Philippines, Poland, Portugal, Romania, Serbia, Singapore, Spain, Sweden, Switzerland, Thailand, Trinidad and Tobago, Turkey, United Kingdom, United States, Uruguay, and6

Venezuela.11 The data are quarterly and cover the period 1970-2011 (not for every countryof course).12
This novel dataset on reserve requirements comes from primary sources such as central
banks’ and government agencies’ websites as well as research and policy papers. In manycases, however, we received invaluable help from sta¤ and researchers at central banks.13 To
set the stage, we begin by brie‡y discussing some broad features of the data.

2.1

Varieties of reserve requirements

We …nd in the data four di¤erent types of arrangements: (i) single reserve requirement; (ii)reserve requirements that vary according to maturity; (iii) reserve requirements that vary
according to currency of denomination; and (iv) reserve requirements that vary according toboth maturity and currency of denomination.14 Figures 1 to 4 present some examples of thosevarieties:
Figure 1 shows the evolution of the single reserve requirement in China. As the …gureclearly illustrates, since 2007 China has made active use of reserve requirements as acountercyclical tool.15
Figure 2 shows the evolution of reserve requirements in Venezuela.

Until the lastquarter of 1990, Venezuela had reserve requirements that varied according to maturity(demand, savings, and term), with the required reserve requirement decreasing with thematurity: 15 percent for demand deposits, 10 percent for saving deposits, and 8 percent
11

For convenience, we will use the term “countries,” but notice that our list includes the Euro zone as asingle economic unit and Ecuador as two di¤erent economic units (before and after full dollarization in theyear 2000).
12
Appendix 2 lists the sample period for every country, the type of legal reserve requirements, and the speci…csource.
13
Our study also uses other macroeconomic variables such as real GDP, in‡ation, and central bank interest
rates, all of them at the quarterly frequency. Real GDP data is seasonally-adjusted. Most of this data weregathered from Global Financial Data and IFS (IMF). See Appendix 1 for a description of data and its sources.
14
Of course, RR may occasionally di¤er according to other factors. China’s Central Bank, for example,
imposes lower RR on rural banks than on major banks. As of April 2014, RR stand at 20 percent for majorbanks and as low as 16 percent for smaller, rural banks.
15
See Ma et al. (2013) for a detailed analysis of RRP in China.

7

for term deposits. This di¤erential reserve requirements structure aimed at discouraging
short-term capital in‡ows and deposits. Since the uni…cation of reserve requirements inthe last quarter of 1990, reserve requirements have changed much more frequently andhave been used as a countercyclical tool.
Figure 3 shows the evolution of reserve requirements in Peru, which vary by currencyof denomination. While both series have comoved positively – partly re‡ecting therecent counter-cyclical use of reserve requirements – foreign-currency-deposits reserve
requirements are much higher (about 4 times as high) than those for domestic-currency
deposits. This di¤erential re‡ects the concerns with sudden reversals in foreign currency‡ows, as discussed in Montono and Moreno (2011), Rossini and Quispe (2010) andRossini et al (2011).
Figure 4 shows the evolution of reserve requirements in Argentina, which vary according
to both maturity and currency of denomination. During the early 1990s, the highest
reserve requirements were for demand deposits, both for local and foreign currency.
Reserve requirements were uni…ed in mid-1995 and remained fairly stable until theend of 2001. Argentina then went back to the pre-1995 regime, with di¤erent reserve
requirements depending on maturity and currency of denomination. Unlike in the pre1995 regime, however, the highest reserve requirements during the early and mid-2000s
were for foreign-currency deposits (both demand and term deposits).
Table 1 illustrates in a more systematic the wide diversity of reserve requirements arrangements in our sample.16

We can see that all industrial countries (including the Euro zone)

fall in the …rst two categories, including Australia, Canada, Denmark, New Zealand, Norway,
Sweden (since 1995), and United Kingdom, which have no legal reserve requirements.

In

contrast, developing countries span the whole spectrum, ranging from Mexico, which has had
zero legal reserve requirements since 1992, to a fairly numerous group that has reserve re16

Single reserve requirements includes the case of no legal reserve requirement.

8quirements that vary according to both maturity and currency of denomination. Developing
countries are fairly evenly distributed across categories: 32 percent have single reserve requirements, 22 percent have reserve requirements that vary according to maturity or currencyof denomination, and about 24 percent of the countries have reserve requirements that vary
according to both maturity and currency of denomination. The existence of reserve requirements based on currency of denomination in many developing countries should perhaps comeas no surprise given the widespread phenomenon of “dollarization” or, more broadly, foreign
currency deposits.17

2.2

Long-run trends

To get an idea of how reserve requirements have evolved over time, Figure 5 plots the average
reserve requirement across countries since 1975 to the present and the corresponding linear
trend.18 On average, developing countries (solid line) have reserve requirements that areabout 7 times higher than those of industrial economies (dashed line). The historical average
reserve requirement for industrial countries is around 0.02, compared to 0.14 for developing
economies.
For developing countries, we can see a clear declining trend re‡ecting …nancial liberalization and …nancial deepening. Reserve requirements reached their highest average values in
the late 1970s (around 0.2), while they got to historical lows in the late 1990s with reserve
requirements averaging 0.1.

We can also see an increase in actual average reserve require-ments in the period 2005-2010 re‡ecting –as discussed in detail below –a more active use of
macroprudential policy in the period surrounding Lehman’s fall on September 15, 2008. We
see a similar declining trend, but much less steeper, for industrial countries.
Figure 6 depicts the dispersion of reserve requirements over time and the corresponding
linear trend.19 For developing countries – and as was the case in Figure 5 – we see a clear
17
For a detailed discussion of dollarization, see Savastano, Reinhart, and Rogo¤ (2003) and the references
therein.
18
This is the simple average of existing reserve requirement for a given country averaged over all countries.
19
We compute the standard deviation of existing reserve requirements for each country and then average

9declining trend with an increase in the actual dispersion over the last 5 years. In otherwords, during the last three decades there has been a convergence in terms of di¤erent reserve
requirements, with the value for 2011 not too far from that for industrial countries. On theother hand, we see essentially no change over time for industrial countries.

2.3

Multiple reserve requirements: Correlation between cyclical components

If countries around the world had a single reserve requirement, the analysis regarding RRP
over the business cycle would be fairly straightforward since we would need to focus only on
the cyclical component of the single reserve requirement. The presence of multiple reserve requirements that vary according to maturity and/or currency presents, in principle, a challenge
for the analysis of RRP. For example, it could be the case that while reserve requirements forone of type of deposits is increasing, the one on some other type of deposits is decreasing. If
this kind of asymmetric pattern across di¤erent reserve requirements were fairly common, it
would be di¢ cult to assess the overall behavior of RRP over the business cycle. Interestingly,
however, while the levels of reserve requirements may vary across di¤erent categories of deposits, their cyclical components appear to be positively related (Table 2). Indeed, in almost
all cases we cannot reject that such correlations are positive and statistically signi…cant.

3

Macroprudential policy over the business cycle

Needless to say, not all countries make use of RR for macroeconomic stabilization purposes.
An obvious example would be countries, such as the industrial countries mentioned above,that have zero legal RR. In other cases, however, RR may occasionally change but owing tomicroprudential reasons (broadly de…ned as including any reason not related to the businesscycle). Since our purpose is to analyze the cyclical properties of RR in those countries that
use them for macroeconomic stabilization purposes, we need an operational de…nition thatacross countries.

10

will allow us to divide countries into those that make active use of RR for such purposes andthose that do not. Once we have put countries into these two categories, we can proceed tocompute the cyclicality of RR policy for the active group.

3.1

Active versus passive countries

To distinguish between active and passive countries, we …rst compute the frequency of changes
in RR. Notice that, unlike standard macroeconomic time series, such as government consumption, which evolve in a continuous fashion over time, the legal RR is a “discontinuous series”
in the sense that it may not change for prolonged periods of time.20 For this type of timeseries, the frequency of changes is an important statistic. Figure 7 illustrates the quarterly
frequency of changes in RR for all the countries in our sample.21 Yellow bars denote developing economies while black bars indicate industrial countries. For example, a frequency of
one indicates that, on average, a country changes RR once per quarter or four times a year,
whereas a frequency of 0.25 indicates a change every four quarters. The …rst obvious messageof this picture is that yellow bars tend to be concentrated on the right-side (indicating frequent changes in RR) whereas black bars tend to be bunched towards the left-side (including
many industrial countries with zero frequency and hence no discernible bar). This alreadytells us that we should expect to …nd many more developing countries in our group of active
users of RR.
Clearly, a country with zero frequency of changes will fall in the category of passive (i.e.,
non-active) countries. A country like Chile with a frequency of 0.016 (having changed RR
only twice in our 31 year-sample) will also fall in the passive category.

But where do we

draw the line? Since we are focusing on the use of RR for macro-stabilization purposes, it
makes sense to think that if a country changes RR at a frequency that is lower than that of20

Other macroeconomic time series that share this property are, for example, prices of goods at a grocery
store or tax rates. The frequency of changes of prices at grocery stores is typically taken as an indicator of
how “sticky” are nominal prices; see, for example, Bils and Klenow (2004).
21
When a country has multiple RR, we compute the frequency for each one and take the average. Generally
speaking, the frequency of changes does not vary substantially across di¤erent RR for a given country.

11its business cycle, it is not actively using RR to smooth out the business cycle. Hence, what
we do is to compute for each country the average duration of the business cycle based onquarterly GDP. If the frequency of changes in RR is higher (lower) than the average cycle,
then we classify that country as an active (passive) country in terms of RR policy.22
Figure 8 uses a scatter plot to illustrate the classi…cation of countries into active andpassive. The horizontal axis measures the average duration (in years) of the business cycle ina given country while the vertical axis measures the time (also in years) between changes in
RR in the same country. Along the 45 degree line, the duration of the business cycle and thetime between changes are the same. Generally speaking, points below the 45 degree line arecountries in which the time between changes in RR is more than the business cycle frequency(active countries), while the reverse is true for countries above the 45 degree line.23 24
Based on Figure 7, 62 percent of countries (32 out of 52) are classi…ed as active countries.
As expected, there is a striking di¤erence between developing and industrial countries: 68
percent (or 27 out of 37) of developing countries are classi…ed as active, whereas only 33
percent of industrial countries (5 out of 15) are classi…ed as active.
In fact, the di¤erence between industrial and developing countries becomes even morestriking if we divide the sample before and after 2004. For the post-2004 sample – and as
Figure 9 illustrates – while the frequency of changes in RR for developing countries looks
roughly similar to the whole sample (Figure 7), there is not a single industrial country thathas changed legal reserve requirements in this period.25 Using our formal criterion, 57 percent
of developing countries (or 21 out of 37) are classi…ed as active in the 2005-2011 period.
22
Formally –and to account for the high variability of the business cycle duration within countries –we willclassify a country as pursuing an active RRP if the average duration between changes in RR is lower than the
average duration of the business cycle plus one standard deviation.
23
Countries with zero frequency of change would have an “in…nite”amount of time between changes and areplotted out of scale.
24
We say “generally”because, to keep it simple, the scatter plot does not allow for the one standard deviationof the business cycle duration embedded in our formal de…nition above. In the …gure, a black dot (cross) denotes
an active (passive) country.
25
Of the 15 industrial countries in this sub-sample, 8 have in fact no legal reserve requirement.

12

3.2

Cyclical properties of reserve requirement policy

Having identi…ed a group of countries which, according to our de…nition, has actively used
RR policy, we can now proceed to compute the cyclical properties of RR policy for thisgroup. Figure 10 depicts the correlation between the cyclical components of RR and GDP
for the 32 countries classi…ed as active.26 We can see that most countries (23 out of 32, or 72
percent) have pursued countercyclical RR policy. In particular, 70 percent (or 19 out of 27)
of developing countries have used RR countercyclically.
Has the use of RR policy for macroprudential purposes changed/intensi…ed in recent times?
As mentioned when discussing Figure 5, it seems that since 2005 or so, countries have resorted
more frequently to macroprudential policy. Dividing the sample again before and after 2004
(Figure 11, Panels A and B, respectively), we can see that before 2005, the number of active
countries with countercyclical RRP was 60 percent (or 18 out of 30) but after 2004 thenumber rises sharply to 90 percent (or 19 out of 21). Particularly striking is the fact that in
the post-2004 period, there is not a single industrial country that has pursued active RRP.
To sum up, we have found that (i) reserve requirements have been used fairly frequently
as a macroeconomic stabilization tool (i.e., countercyclically); (ii) their use has increased
considerable since 2004, which is consistent with anecdotal evidence to this e¤ect, and (iii) no
industrial country has used RRP actively in the post-2004 period.

4Complementarity/substitutability with monetary policy

In and of itself, the fact that 53 percent (or 10 out of 19) percent of active developing countries(and 71 percent after 2004) have, on average, pursued countercyclical RR policy may notseem that remarkable.27

But it is indeed remarkable when compared to the percentage

of developing countries that have pursued countercyclical monetary policy.28
26

Figure 12

When a country has multiple RR, we compute the correlation between the cyclical component of RR and
GDP for each one and then take the average. It is important to recall that, as discussed in subsection 2.3, thecyclical components of RR are strongly positively related in countries with multiple RR.
27
We are referring here to correlations which are signi…cantly di¤erent from zero.
28
See Vegh and Vuletin (2012) for a detailed analysis of the cyclicality of monetary policy.

13

depicts the correlation between the cyclical components of policy interest rates and GDP ona quarterly basis.

We can see that 73 percent (11 out of 15) industrial countries (blackbars) exhibit a signi…cant positive correlation indicating countercyclical monetary policy. In
sharp contrast, only 27 percent (of 22 out of 37) show countercyclical monetary policy (i.e., asigni…cantly positive correlation). In fact, the average correlation for industrial countries is0.40 (and signi…cantly di¤erent from zero), compared to 0.07 (and not signi…cantly di¤erent
from zero) for emerging countries.

In other words, the average industrial country pursues

countercyclical monetary policy, whereas the average emerging country is acyclical.
Why do we see such a sharp di¤erence in the conduct of monetary policy between industrial
and developing countries? Vegh and Vuletin (2012) argue that a critical factor is the “fearof free falling,” de…ned as the need for developing countries to defend their currency in bad
times. While a typical industrial country can lower interest rates in bad times without thefear of a sharp depreciation of their currency, this is often not true of developing countries.
In bad times, when capital is ‡owing out and credibility is at a low point, many developing
countries see the value of their currency plummet.

In those circumstances, the monetary

authority may have no choice but to either increase the interest rate to defend the currency(or at least not reduce it for fear of exacerbating the fall).29 As a result, policymakers increaseinterest rates to avoid/delay the capital out‡ow at the same time that they decrease RR tospur the economy (by reducing the lending spread).
An analogous story is true for good times, in what we could refer to as “fear of capitalin‡ows.” The idea is that in periods of capital in‡ows (and ensuing output boom), themonetary authority is reluctant to raise interest rates because of the fear of attracting evenmore capital in‡ows (or fear of currency appreciation). As a result, policymakers either keep
29

In fact, this has been part of the standard IMF policy advice to developing countries, most notably during
the Asian crisis of 1997. To quote Stanley Fischer, at the time the IMF’s First Deputy Managing Director, ina 1998 lecture delivered at UCLA, “[i]n weighing this question [are the IMF programs in Asia too tough?], it
is important to recall that when they approached the IMF, the reserves of Thailand and Korea were perilously
low, and the Indonesian rupiah was excessively depreciated. Thus, the …rst order of business was, and stillis, to restore con…dence in the currency. To achieve this, countries have to make it more attractive to holddomestic currency, which, in turn, requires increasing interest rates temporarily, even if higher interest costs
complicate the situation of weak banks and corporations.”

14

interest rates unchanged or even lower them to attract less capital in‡ows at the same timethat they raise RR to cool o¤ the economy (by increasing the lending spread).30
This implies that developing countries may be caught in the common policy dilemma of
too few instruments (the policy interest rate) relative to the number of targets (output andthe nominal exchange rate). Viewed in this light, it is perhaps not surprising to see developing
countries resort to the use of reserve requirements in a countercyclical manner, as they provide
the second instrument that may be needed to achieve the two targets just mentioned. In otherwords, during bad times a country may not be able to lower interest rates (as it would like,were it not for the fear of free falling), but may lower reserve requirements instead. Similarly,
during good times a country may not be able to increase interest rates (as it would like, were
it not for the fear of capital in‡ows), but may increase reserve requirements instead. In otherwords, RRP is acting as a substitute for monetary policy.
On the other hand, there are emerging markets that do not su¤er from the fear of freefalling and capital in‡ows and may therefore be able to pursue countercyclical monetary
policy. If, in addition, they also use reserve requirements in a countercyclical way, we say that
RRP is acting as a complement for monetary policy since both instruments are being used
for the same purpose (to increase output in the case of a recession).
Table 3, which will be referred to as the policy mix matrix, classi…es countries according
to the cyclical properties of both monetary and reserve requirement policies. Since countries
may be procyclical, acyclical, or countercyclical, there are 9 possible cells or combinations.
Notice that most industrial countries are on the second row because most of them are acyclicalwhen it comes to RRP (i.e., they do not use RRP for macroeconomic stabilization purposes).
In fact, most industrial countries (11 out of 15 or 73 percent) fall in the (2,3) cell, coloredorange, given that their monetary policy is countercyclical.
In contrast, 10 developing countries (or 27 percent of all developing countries in our
30

As an example, this was the position of the Turkish Central Bank as described in a Financial Times article
on Dec 13, 2010. The deputy governor argued that the way to deal with heavy capital in‡ows was to reduce
interest rates (to reduce capital in‡ows and currency appreciation) while using other instruments (i.e., reserve
requirements) to reduce credit growth.

15

sample) fall in the third row because they exhibit countercyclical RRP. Of these 10 developing
countries, six fall in the cell (3,2) given that they have had acyclical monetary policy, while
the remaining four fall in cell (3,3) because they have had countercyclical monetary policy.
As a matter of de…nition, we will refer to countries falling in cell (3,3) as using RRP as acomplement to monetary policy in the sense that both policies reinforce each other. These
are cases in which both RRP and monetary policy are countercyclical, so that in good (bad)times both RR and the policy interest rate are increased (lowered).

In contrast, countries

that fall in cell (3,2) and, potentially, cell (3,1) are cases in which RRP acts a substitute forinterest rate policy because reserve requirements perform the function that the interest ratecannot due to the need of either defending the currency in bad times or not attracting more
capital in‡ows in good times.
Further, we interpret cell (2,1) as “bad place”to be because here countries feel compelled
to use monetary policy procyclically but are not taking advantage of reserve requirements asa second instrument. On the other hand, we can view (2,3) as the “promised land,”in termsof policymaking.

The reason is that here countries can use monetary policy for counter-

cyclical purposes without fearing the e¤ects of countercyclical interest rates on the exchange
rate and/or capital in‡ows, presumably re‡ecting a high degree of policy and institutional
credibility.31
As before, we break the sample into before and after 2004 and construct the policy matrices
for each period, as illustrated in Table 4.

Comparing the pre and post-2004 policy mix

matrices in Table 4, Panels A and B, three important changes are worth noting: (i) the
number of developing countries pursuing procyclical interest rate policy falls from seven in
the early period to just one in the more recent period; (ii) the number of developing countries
engaging in countercyclical RRP increases from 7 to 15, and (iii) developing countries using
monetary policy and RRP as substitutes (as captured in cell (2,2)) increases from 5 to 8
whereas developing countries using monetary policy and RRP as complements (as captured
31
Of course, countries may still want to use RR for microprudential purposes, so “promised land” refers
exclusively to countries not needing to use RR as a macrostabilization tool.

16

in cell (3,3)) increases from 2 to 7.32
In this context, one can imagine di¤erent “routes” that countries may take in the policy
journey from cell (2,1), a “bad place to be”, to cell (2,3), the “promised land”. One route
would be the “direct route” that Chile took. Notice that Chile went from cell (2,1) in thepre-2005 period to cell (2,3) in the post-2004 period. This is remarkable because, in our view,it can only happen in the context of a notable improvement in policy/institutional credibility.
In such a case, a country like Chile may not need to resort to countercyclical RRP, which ispresumably the situation of a typical industrial country.33
A more common route (involving several stages, so to speak) would be to go from cell (2,1)
to cell (3,2), then to cell (3,3), and …nally to cell (2,3). One could even add an additional
stage in which countries would go from cell (2,1) to cell (2,2) and only then to cell (3,2).
Mexico and Uruguay, for instance, have gone from cell (2,1) in the pre-2005 period to cell(2,2) in the post-2004 period. This is presumably an improvement in the policy mix because
they have graduated from monetary policy procyclicality but the fact that they are in cell(2,2) implies that they have no countercyclical tool.34 In principle, they would bene…t frommoving to cell (3,2) where they would be using reserve requirements as a countercyclical tool.

5

Taylor rules

Sections 3 and 4 showed suggestive evidence on the use of reserve requirements for macroprudential purposes and illustrated the fact that RRP often acts as a substitute for monetary
policy. We also provided a rationalization, based on fear of free falling in bad times and fear
32

While clearly suggestive, we should note that the policy mix matrices should be taken with a slight grainof salt to the extent that they are capturing an “average behavior” of any given country over a very long time
horizon and thus are completely missing the time series dimension. Below we will compute implicit Taylor
rules using panel data which, to the extent that they will indeed capture the time series dimension, should
provide a more accurate picture of the complementary/substitutability of monetary and reserve requirement
policy.
33
This would be a “one-step” graduation process, which is the one (implicitly) highlighted by Vegh, andVuletin (2012) for the case of monetary policy and Frankel, Vegh, and Vuletin (2011) for the case of …scal
policy. For a more detailed analysis of institutional changes that may have allowed Chile to graduate, seeFrankel (2011).
34
Not even …scal policy because, according to Frankel, Vegh, and Vuletin (2013), both Mexico and Uruguay
continue to be procyclical even in the more recent period.

17

of capital in‡ows in good times, for such a policy mix. This section presents a more formal
analysis that provides evidence on these empirical regularities and sheds light on the policy
channels discussed above. For this purpose we estimate “expanded”Taylor rules for developing countries over the period 2005-2011; which saw the heaviest use of reserve requirements
as a countercyclical tool (Section 3).35

By “expanded” Taylor rules, we mean Taylor rules

which, in addition to the output and in‡ation gaps, include the nominal exchange rate gap (see, for instance, Corbo, 2000, and Moron and Winkelried, 2005). The nominal exchange rate
gap captures policymakers’concerns about “excessive”depreciation (appreciation) during bad(good) times, as discussed above.
Table 5 shows Taylor rules for both monetary and reserve requirements for countries thathave used RRP actively since 2005. We estimate these policy reaction functions using a systemof simultaneous equations.36 Column 1a shows the traditional Taylor rule with output andin‡ation gap, while column 1b shows the same rule for reserve requirements.

Columns 2a

and 2b show the results for the case that the rules include the output and nominal exchange
rate gaps. Columns 3a and 3b shows the rules for the case in which all three gaps (output,in‡ation, and nominal exchange rate) are included.37;38 Columns 3a,b include output andin‡ation gaps, and output and nominal exchange rate gaps, respectively.
Turning now to the results, columns 1a and 1b illustrate the fact that, as shown in Sections
3 and 4, monetary policy is acyclical whereas RRP is countercyclical. In other words, RRP
acts as a substitute for monetary policy.

Columns 2a and 2b are consistent with columns

1a and 1b regarding the cyclicality of the policy rate and reserve requirements but illustrate
the importance of nominal exchange rate ‡uctuations for monetary policy. In particular –and as discussed in Section 4 –the policy rate reacts positively to the nominal exchange rate
35

Similar results are obtained if the entire period was used.
In case of multiple RR, we calculate the cyclical component of the average RR by averaging the cyclicalcomponents of each RR.
37
The nominal exchange rate is de…ned as units of local currency per dollar. Therefore an increase (decrease)in the nominal exchange rate represents a depreciation (appreciation) of the local currency.
38
We calculate the cyclical component of growth rate of the nominal exchange rate as opposed to the one
for level of nominal exchange rate.
36

18

gap, which captures the fear of free falling (higher interest rates in response to a nominal
depreciation ) and fear of capital in‡ows (lower interest rate in response to a nominal appreciation). To sum up, monetary policy responds positively to exchange rate depreciations and
RRP focuses on the output gap in a countercyclical way.39 In other words, RRP substitutes
for monetary policy.
Table 6 shows Taylor rules for monetary policy for countries that did not use RR policy
actively since 2005.

Columns 1 and 2 show the results when including the output andin‡ation gaps, and output and nominal exchange rate gaps, respectively. Column 3 includes
output, in‡ation, and nominal exchange rate gaps. In sharp contrast to the active countries
considered in Table 5, passive countries have been able to use monetary policy to respond to
output ‡uctuations in a countercyclical way. In addition, they have also responded positively
to the in‡ation and exchange rate gaps.

It is interesting to note that the coe¢ cient ofvariation –de…ned as the ratio between the standard deviation and its mean–of the (cyclicalcomponent) of the nominal exchange rate for countries that use RRP actively is about 7
times that of countries that are categorized under passive users of RR policy.40 This striking
di¤erence in exchange rate volatility since 2005 together with the asymmetric response ofmonetary and reserve requirement policies depicted in Tables 5 and 6 provide support for
our arguments regarding the mechanisms involved, the role of fear of free falling and capitalin‡ows, and the underlying reasons for RRP to substitute (if necessary) for monetary policy.

6

Conclusions

Using a unique and novel database, this paper has uncovered several stylized facts regarding the use of reserve requirements as a macroeconomic stabilization tool and its relation
to monetary policy.

In particular, we have seen that around 2/3 of emerging markets use

39

The signi…cance of the nominal exchange rate weakens a little bit (column 3a) due to multicolinearity
between in‡ation and exchange rates gaps.
40

The coe¢ cient of variation of nominal exchange rate for active users of RR is 112.6, while the one forpassive users is 16.9.

19

reserve requirements as a macroeconomic stabilization tool and most of them use them countercyclically. At the same time, many developing countries engage in procyclical monetary
policy, raising interest rates in bad times and lowering them in good times. We argue thatprocyclical monetary policy may re‡ect the fear of free falling (the need to defend the currency in bad times by raising policy rates) and the fear of capital in‡ows (the reluctance toraise policy rates in good times for fear of attracing even more capital in‡ows and further
appreciate the domestic currency). In such a scenario, by providing a countercyclical tool,
reserve requirements perform the work that monetary policy cannot do (and, in that sense,
reserve requirement policy acts as a substitute for monetary policy).

Appendix 1. De…nition and sources of variables
All data are at quarterly frequency. X-12-ARIMA is used for seasonal adjustment of realGDP. Cyclical components were obtained using the Hodrick-Prescott …lter.
Real GDP: Most data are from Global Financial Data and International Financial Statistics (IFS/IMF). Data are also complemented in some cases with local sources: Argentina(Central Bank of Argentina), Brazil (Institute for Applied Economic Research - IPEA), Honduras (Central Bank of Honduras), Panama (Central Bank of Panama), Trinidad and Tobago(Central Bank of Trinidad and Tobago), and Uruguay (Central Bank of Uruguay).
Interest rate policy: We take short-term interest rates as a proxy for the stance of monetary policy. In some cases, we have data for overnight interbank interest rates, such as theFederal Funds rate in the United States. In most cases, however, we rely on discount rates
due to their longer availability. Source: Global Financial Data.
Legal reserve requirements: See Appendix 2 for details.
In‡ation: Based on consumer price index. Source: Global Financial Data.
Nominal exchange rate: Nominal bilateral exchange rate (against USD). Source: IFS/IMF.

20

Appendix 2. Legal reserve requirements. Source, data coverage, and typeType of legal reserve requirements: S, M, and C stand for single, maturity, and currency denomination.

Country

SourceData Coverage

Type

Albania

Central Bank Email

1992:Q1-2011:Q4

S

Argentina

Central Bank Website

1990:Q1-2011:Q3

C&M

Australia

Paper

1988:Q1-2011:Q4

S

BahamasCentral Bank Website

1974:Q2-2011:Q4

M

Bangladesh

Central Bank Website

1993:Q1-2011:Q4

S

BelarusCentral Bank Website

1992:Q1-2011:Q4

C&M

BelizeCentral Bank Website

1977:Q1-2011:Q4

S

BrazilPapers1969:Q1-2010:Q4

M

CanadaGovernment Website

1994:Q1-2011:Q4

S

Chile

Central Bank Email

1975:Q1-2011:Q4

M

China

Central Bank Email

1985:Q1-2011:Q4

S

Colombia

Central Bank Email

1970:Q1-2011:Q4

S

Costa Rica

Central Bank Email

1987:Q3-2011:Q4

C&M

Croatia

Central Bank Website

2002:Q1-2011:Q4

CCuracao

Central Bank Website

1995:Q4-2011:Q4

S

Czech
Republic

Central Bank Website

1993:Q1-2011:Q4

M

Denmark

Central Bank Email

1970:Q2-2011:Q4

S

Dominican
Republic

Central Bank Website and Papers

1970:Q1-2001:Q4

M

ECCB

Papers1983:Q1-2011:Q4

S

EcuadorCentral Bank Website

1988:Q1-2011:Q4

C&M

El Salvador

Central Bank Website

2001:Q1-2011:Q4

M

Euro

Papers and Central Bank Website

1998:Q1-2012:Q1

M

FrancePapers and Central Bank Website

1989:Q4-2012:Q1

M

Germany

Papers and Central Bank Website

1989:Q4-2012:Q1

M

GuatemalaCentral Bank Website

1992:Q1-2011:Q4

C

Honduras

Central Bank Website

2001:Q4-2011:Q4

C

Hungary

Central Bank Website

1994:Q1-2011:Q4

M

India

Central Bank Paper and IMF Email

1970:Q1-2011:Q4

SIndonesia

IMF Email2009:Q4-2011:Q4

S

IsraelCentral Bank Email

1988:Q1-2011:Q4

M

Jamaica

Papers1984:Q1-2010:Q3

C

Japan

Central Bank Website

1970:Q1-2011:Q4

M

LatviaCentral Bank Email

1993:Q1-2011:Q4

M

21

Country

SourceData Coverage

Type

Lithuania

Central Bank Email

1990:Q3-2011:Q4

C

Macedonia

Central Bank Website

2004:Q1-2011:Q4

C

Malaysia

Central Bank Website and IMF Email

1989:Q1-2011:Q4

S

Mexico

IMF Papers

1988:Q1-2011:Q4

S

Moldova

Central Bank Website

2004:Q1-2011:Q4

S

New ZealandPaper

1988:Q1-2011:Q4

S

NicaraguaCentral Bank Website

2001:Q4-2011:Q4

C

NorwayCentral Bank Email

1970:Q1-2011:Q4

SPakistan

IMF Email1970:Q1-2011:Q4

S

PanamaCentral Bank Website

1998:Q1-2013:Q4

S

Peru

Central Bank Email

1993:Q1-2011:Q4

C

Philippines

Papers and IMF email

2004:Q1-2011:Q4

S

PolandCentral Bank Website

1993:Q1-2011:Q4

C&M

Portugal

Papers1988:Q1-2012:Q1

M

Romania

Central Bank Email

1992:Q1-2011:Q4

C&M

SerbiaCentral Bank Email

2002:Q2-2010:Q4

CSingapore

Central Bank Email

1991:Q1-2011:Q4

S

Spain

Papers1990:Q1-2012:Q1

S

Sri Lanka

Central Bank Website

1999:Q1-2011:Q4

S

SwedenCentral Bank Email

1970:Q1-2011:Q4

S

Switzerland

Central Bank Email

1988:Q1-2011:Q4

M

ThailandCentral Bank Website

1970:Q1-2011:Q4

S

Trinidad &TobagoCentral Bank Website

1970:Q1-2011:Q4

S

TurkeyPaper

1988:Q3-2011:Q1

C&M

Uruguay

Central Bank Email

1983:Q4-2011:Q4

C&M

UK

Central Bank Website

1981:Q3-2011:Q4

S

USA

Papers1970:Q1-2011:Q4

M

Venezuela

Central Bank Website

1970:Q1-2011:Q4

M

22

.

References[1] Bils, Mark, and Peter J. Klenow (2004), “Some evidence on the importance of sticky
prices,” Journal of Political Economy, Vol. 112, pp. 947-985.
[2] Borio, C., and I. Shim (2007), “What can (macro-)prudential policy do to support monetary policy?” BIS Working Papers No. 242.
[3] Calderon, Cesar, and Luis Serven (2011), “Macro-prudential policies over the cycle in
Latin America,” unpublished manuscript (World Bank).
[4] Canuto, Otaviano and Swati R. Ghosh (2013), editors, Dealing with the challenges ofmacro …nancial linkages in emerging markets, World Bank.
[5] Claessens, Stijn, Swati R. Ghosh, and Roxana Mihet, “Macro prudential policies tomitigate …nancial vulnerabilities in emerging markets,” in Otaviano Canuto and Swati
R. Ghosh, editors, Dealing with the challenges of macro …nancial linkages in emerging
markets, World Bank (2013), pp. 155-178.
[6] De Gregorio, Jose, Sebastian Edwards, and Rodrigo Valdes (2000), “Controls on capitalin‡ows: Do they work?” NBER Working Paper No. 7645.
[7] De la Torre, Augusto, Alain Ize, and Sergio Schmukler (2012), Financial development in
Latin America and the Caribbean (World Bank: Latin American and Caribbean Studies).
[8] Fischer, Stanley (1998), “The IMF and the Asian Crisis,” Speech delivered at UCLA
(available on the IMF website).
[9] Frankel, Je¤rey, Carlos A. Vegh, and Guillermo Vuletin (2013), “On graduation from…scal policy procyclicality,” Journal of Development Economics, Vol. 100, pp. 32-47.

23

[10] Glocker, C., and P. Towbin (2012), "The Macroeconomic e¤ects of reserve requirements,"
Austrian Institute of Economic Research, Working Paper No. 420/2012.
[11] IMF (2011), Shifting winds, new policy challenges (Regional Economic Outlook, Western
Hemisphere Department).
[12] IMF (2012), The liberalization and management of capital ‡ows: An institutional view.
[13] Lim, C, F. Columba, A. Costa, P. Kongsamut, A. Otani, M. Saiyid, T. Wezel, and X.
Wu (2011), “Macroprudential policy: What instruments and how to use them?” IMF
Working Paper 11/238.
[14] Ma, Guonan, Yan Xiandong and Liu Xi (2013), “China’s evolving reserve requirements,”
Journal of Chinese Economic and Business Studies, Vol. 11.
[15] Montoro, C., and R. Moreno (2011), “The use of reserve requirements as a policy instrument in Latin America,” BIS Quarterly Review (March).
[16] Nier, E., J. Osinski, L. Jacome, and P. Madrid (2011), “Towards e¤ective macroprudential
policy frameworks: An assessment of stylized institution models,” IMF Working Paper
11/250.
[17] Rossini, Renzo and Zenon Quispe (2010), “Monetary policy during the global …nancial
crisis of 2007-2009: The case of Peru,” Bank for International Settlements (Vol. 54), pp.
299-315.
[18] Rossini, Renzo, Zenon Quispe and Donita Rodriguez (2011), “Capital ‡ows, monetary
policy and FOREX interventions in Peru” Working Paper 2011-008 (Central Reserve
Bank of Peru).
[19] Reinhart, C., K. Rogo¤ and M. Savastano (2003), “Addicted to dollars,”NBER Working
Paper No. 10015.

24

[20] Tovar, Camilo, M. Garcia-Escribano, and M. Vera (2012), “Credit growth and the e¤ectiveness of reserve requirements and other macroprudential instruments in Latin America,” IMF Working Paper No. 142.
[21] Vargas, H., Betancourt, Y., Rodriguez, N. and Varela, C. (2010): “E¤ects of reserve
requirements in an in‡ation targeting regime: the case of Colombia,”BIS Papers, no 54,
pp 133–70.
[22] Vegh, Carlos A. and Guillermo Vuletin, “Overcoming the fear of free falling: Monetary
policy graduation in emerging markets,”NBER Working Paper No. 17753 (2012), forthcoming in The role of Central Banks in …nancial stability: How has it changed? (Federal
Reserve Bank of Chicago).

25

Demand

SavingsTerm

2006:1

2005:1

2004:1

2003:1

2002:1

2001:1

2000:1

1999:1

1998:1

1997:1

1996:1

1995:1

1994:1

1993:1

1992:1

1991:1

1990:1

1989:1

1988:1

1987:1

1986:1

1985:1

2011:10
2010:10.05

2010:30.1
2009:1

0.15

2009:1

0.2
2008:10.25

2007:3

0.3

2006:10.35
2007:1Figure 2. Venezuela's reserve requirements over time

2004:3

2003:1

2001:3

2000:1

1998:3

1997:1

1995:3

1994:1

1992:3

1991:1

1989:3

1988:1

1986:3

1985:1

1983:3

1982:1

1980:3

1979:1

1977:3

1976:1

1974:3

1973:1

1971:3

1970:1

Reserve requirement

Reserve requirement

Figure 1. China's reserve requirement over time.

0.25

0.2

0.15

0.1

0.05

0

Local-Demand

Local-Term

Foreign-Demand

0.25

0.2

0.15

0.1

0.05

0
2008:1

2007:2

2006:3

2005:4

2005:1

2004:2

2003:3

2002:4

2002:1

2001:2

2000:3

1999:4

1999:1

1998:2

1997:3

1996:4

1996:1

1995:2

1994:3

1993:4

1993:1

Foreign-Term

Note: RR associated with savings deposits are the same than those of demand deposits, both for local and foreign currency.
2011:4

2011:1

0.3

2011:10.35
2010:20.4

2010:20.45
2009:3

0.5

2009:3Figure 4. Argentina's reserve requirements over time
2008:4Foreign

2008:4

2008:1

2007:2

2006:3

2005:4

2005:1

2004:2

Local

2003:3

2002:4

2002:1

2001:2

2000:3

1999:4

1999:1

1998:2

1997:3

1996:4

1996:1

1995:2

1994:3

1993:4

1993:1

Reserve requirement

Reserve requirement

Figure 3. Peru's reserve requirements over time

0.6

0.5

0.4

0.3

0.2

0.1

0

Developing

Industrial

2011

2009

2007

2005

2003

2001

Developing

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

Dispersion of reserve requirements

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

Average reserve requirement

Figure 5. Average reserve requirements over time

0.25

0.2

0.15

0.1

0.05

0

Industrial

Figure 6. Dispersion of reserve requirements over time

0.1

0.08

0.06

0.04

0.02

0

India

0.75

0.5

0.25

0

Australia
CanadaDenmark
Domincan Rep.
El Salvador
Euro-17
Guatemala
New Zealand
NorwaySwitzerland
United Kingdom
Singapore
ThailandChile
MexicoUnited States
PanamaSpain
Czech Rep.
FranceMacedonia
Uruguay
Germany
Lithuania
Portugal
IsraelJapan
Philippines
Ecuador (dollarization)
Venezuela
Hungary
SwedenBrazilPolandRomania
TurkeyPeru
Colombia
Croatia
Trinidad and Tobago
Ecuador (pre-dollarization)
LatviaMalaysia
China
Nicaragua
BelarusCosta Rica
Jamaica
Argentina
SerbiaHonduras

Quarterly frequency of changes in reserve requirements

Figure 7. Frequency of changes in reserve requirements (1970-2011)

Figure 8. Active versus passive reserve requirement policy (1970-2011)

Time between changes in RR (in years)

Infinite

Passive

25

Active

20

15

10

5

0
0

2

4

6

8

10

Duration of business cycle (in years)

Note: The dashed line is a 45 degree line. Countries located below (above) the 45 degree line are countries for which the change inreserve requirements takes place, on average, at least (less than) one time per business cycle. Countries are classified as active if theaverage duration of business cycle plus one standard deviation of business cycle is larger than the average time between changes inreserve requirements.

Correlation (RGDP, reserve requirement)

1

0.5

0

-0.5
Nicaragua
Japan
India
Argentina
Ecuador (dollarization)
Philippines
IsraelSweden*SerbiaRomania
Belarus*
Honduras
FranceBrazil*Hungary*
Venezuela*
Peru*
China*
Lithuania*
Germany*
Latvia*Croatia*
Malaysia*

0Australia
CanadaDenmark
MexicoNew Zealand
NorwaySingapore
SwedenThailand
United Kingdom
Guatemala
Chile
Czech Rep.
El Salvador
Euro-17IsraelJapan
Switzerland
United States
Hungary
Uruguay
PanamaCosta Rica
Lithuania
EcuadorMacedonia
PolandPhilippines
Argentina
Jamaica
BrazilNicaragua
Romania
Malaysia
Colombia
TurkeyTrinidad and Tobago
LatviaCroatia
Venezuela
BelarusSerbiaPeru
Honduras

0.25

Jamaica*
Trinidad and Tobago
Ecuador (pre-dollarization)
Colombia
Uruguay
Costa Rica
Portugal
PolandTurkey

0.5
China
India

Quarterly frequency of change of reserve requirement

Figure 9. Frequency of changes in reserve requirements (2005-2011)
0.75

Figure 10. Cyclicality of reserve requirement policy (1970-2011)

Av. industrial = 0.30*
Av. developing = 0.18*

67% of industrial countries excluded
27% of developing countries excluded-1

Note: Average reserve requirement is used for calculations. Sample only includes active reserve requirement policy countries (5 of 15
industrial countries and 19 of 37 developing economies are active). * indicates that the correlation is statistically positive at five percent
level.

Germany*

Venezuela*

Peru*

Hungary*

Brazil*China*

Croatia

Latvia*France*Sweden*SerbiaIsraelJapan

BelarusArgentina
Portugal

Trinidad and Tobago

Uruguay

PolandJamaica

TurkeyCosta Rica

Romania

Ecuador (pre-dollarization)-0.5

Colombia*

India

0

Czech Rep.

67% of industrial countries excluded
32% of developing countries excluded

0.5

Lithuania

Av. industrial = 0.25*
Av. developing = 0.10*

Nicaragua

Correlation (RGDP, reserve requirement)

1

Malaysia*

Figure 11. Panel A. Cyclicality of reserve requirement policy (1970-2004)-1
Note: Average reserve requirement is used for calculations. Sample only includes active reserve requirement policy countries (5 of 15
industrial countries and 25 of 37 developing economies are active). * indicates that the correlation is statistically positive at five percent
level.

Latvia*China*

Argentina*

Lithuania*

India*

Belarus*

Croatia*

Turkey*Malaysia*

Colombia*

Brazil*Venezuela*

Peru*

Poland*HondurasPhilippines

SerbiaNicaragua

0.5

0Av. developing = 0.47*-1Jamaica*-0.5

Trinidad and Tobago*

Correlation (RGDP, reserve requirement)

1

Romania*

Figure 11. Panel B. Cyclicality of reserve requirement policy (2005-2011)

100% of industrial countries excluded
43% of developing countries excluded

Note: Average reserve requirement is used for calculations. Sample only includes active reserve requirement policy countries (21 of 37
developing economies are active). * indicates that the correlation is statistically positive at five percent level.

Correlation (RGDP, central bank interest rate)

1

0.75

0.5

0.25

0

-0.25

-0.5

-0.75

-1

-1.25

Belarus
SwedenLatviaPortugal
Croatia
BrazilJamaica
Nicaragua
Japan
NorwayPhilippines
SerbiaMalaysia
Denmark*
PanamaEcuador (dollarization)
Colombia*
Trinidad and Tobago
Lithuania*
New Zealand*
Czech Rep.*
United States*
United Kingdom*Singapore*
Guatemala*
Poland*Peru*
Spain*
China*
Germany*
Australia*
Canada*El Salvador*
France*Honduras*
Switzerland*
Euro-17*

1.25

Uruguay*
Ecuador (pre-dollarization)*
Domincan Rep.*
Argentina*
India*
Mexico*Chile*
Costa Rica
Macedonia
Romania
IsraelVenezuela
ThailandTurkeyHungary

Figure 12. Cyclicality of interest rate policy (1970-2011)

Av. industrial = 0.40*
Av. developing = 0.07

Table 1. Varieties of reserve requirements
Single RR (19)Developing (37)

Industrial (15)Maturity RR (16)China
Colombia
Ecuador (after dollarization)
India
Jamaica
Malaysia
MexicoPanamaPhilippines
Singapore
ThailandTrinidad and Tobago

BrazilChile
Czech Rep.
El Salvador
Hungary
IsraelLatviaVenezuela

Australia
CanadaDenmark
New Zealand
NorwaySwedenUnited Kingdom

Euro
FranceGermanyJapan
Portugal
Spain
Switzerland
United States

Currency RR (8)Croatia
GuatemalaHonduras
Lithuania
Macedonia
Nicaragua
Peru
SerbiaMaturity and currency RR (9)Argentina
BelarusCosta Rica
Dominican Republic
Ecuador (before dollarization)
PolandRomania
TurkeyUruguay

Table 2. Correlations between the cyclical components of multiple reserve requirements
Panel A. Reserve requirements that vary according to maturity
RR demand
RR savings
RR term

RR demand RR savings
1
0.56***
1
0.61***
0.75***

RR term

1

Panel B. Reserve requirements that vary according to currency of denomination
RR local
RR foreign

RR local
10.31***

RR foreign
1

Panel C. Reserve requirements that vary according to maturity
and currency of denomination
RR demand-local
RR savings-local
RR term-local
RR demand-foreign
RR savings-foreign
RR term-foreign

RR demand-local
1
0.61***
0.32***
0.31***
0.22***
0.26***

RR savings-local

RR term-local

1
0.27***
0.26***
0.34***
0.10**

1
0.06
0.01
0.28***

RR demand-foreign RR savings-foreign

1
0.98***
0.57***

1
0.49***

RR term-foreign

1

Table 3. Policy mix matrix (1970-2011)
Central bank interest rate policy
Pro-cyclicalA-cyclicalCounter-cyclical

Jamaica

Pro-cyclical

Reserverequirement policy

A-cyclical

Israel, Japan, Macedonia,
Argentina,Chile, Costa Rica,
Nicaragua, Panama, Philippines,
Domincan Rep., Ecuador (prePortugal, Romania, Serbia,
dollarization), India, Mexico, Uruguay
Thailand, Turkey

Belarus, Brazil, Croatia, Hungary,
Latvia, Sweden, Venezuela

Counter-cyclical

Australia, Canada, Colombia,
Czech Rep., Denmark, Ecuador(dollarization), El Salvador, Euro-17,
France, Guatemala, Honduras, New
Zealand, Norway, Poland,
Singapore, Spain, Switzerland,
Trinidad and Tobago, United
Kingdom, United States
China, Germany, Lithuania,
Malaysia, Peru

Substitutes

Complements

Table 4. Panel A. Policy mix matrix (1970-2004)
Central bank interest rate policy
Pro-cyclicalA-cyclical

Colombia

Pro-cyclical

Reserverequirement policy

A-cyclicalCounter-cyclicalArgentina, Chile, Domincan Rep.,
Ecuador, India, Mexico, Uruguay

Belarus, Costa Rica, Croatia, Czech
Rep., Denmark, El Salvador,
Australia, Canada, Euro-17,
Guatemala, Israel, Jamaica, Japan,
Lithuania, New Zealand, Poland,
Macedonia, Nicaragua, Norway,
Singapore, Spain, Switzerland,
Panama, Philippines, Portugal,
United Kingdom, United States,
Romania, Serbia, Thailand, Trinidad
and Tobago, Turkey
Brazil, Hungary, Latvia, Malaysia,
Sweden, Venezuela

Counter-cyclical

China, France, Germany, Peru,

Substitutes

Complements

Table 4. Panel B. Policy mix matrix (2005-2011)
Central bank interest rate policy
Pro-cyclical

Reserverequirement policy

A-cyclicalCounter-cyclical

Pro-cyclical

Jamaica

Trinidad and Tobago

A-cyclical

Ecuador (dollarization), Hungary,
Macedonia, Mexico, Nicaragua,
Panama, Philippines, Serbia,
Thailand, Uruguay,

Australia, Canada, Chile, Czech
Rep., Denmark, El Salvador, Euro17, Guatemala, Honduras, Israel,
Japan, New Zealand, Norway,
Singapore, Sweden, Switzerland,
United Kingdom, United States

Costa Rica

Argentina, Belarus, Brazil, China,
Colombia, India, Latvia, Malaysia,
Croatia, Lithuania, Romania, Turkey Peru, Poland, Venezuela

Counter-cyclical

Substitutes

Complements

Table 5. Taylor rules for monetary and reserve requirement policies
for countries with active reserve requirement policy (2005-2011)
i gap

rr gapi gap

rr gapi gap

rr gap

(1a)

(1b)

(2a)

(2b)

(3a)

(3b)

RGDP gap

0.016
[1.4]

0.054***
[2.9]

0.005
[0.4]

0.055***
[3.1]

0.015
[1.3]

0.056***
[3]

π gap

0.001
[1.4]

-0.001[-1.4]

0.001
[1.2]

-0.001[-1.3]NER gap

0.055***[2.8]-0.037[-1.3]

0.034*[1.8]-0.037[-1.2]

Observations

345

345

349

349

345

345

Number of countries

14

14

14

14

14

14

Note: NER stands for nominal exchange rate.

Table 6. Taylor rules monetary policy for countries
with passive reserve requirement policy (2005-2011)
(1)

(2)

(3)

RGDP gap

0.115***[2.8]

0.119***[2.8]

0.091**[2]

π gap

0.152*[1.8]

NER gap

0.175*[1.8]
0.038**[2.1]

0.043**[2.2]

Observations

934

834

777

Number of countries

36

36

36

Note: NER stands for nominal exchange rate.