on the contrary, there are strong indications that this trend will persist, or even be amplified, following the crisis. how much reserves are enough? theoretical reasoning would balance the benefits of holding reserves against their cost, with some notion that there is an optimum. on the benefit side, reserves can be detained or accumulated for a variety of motives : to smooth out the impact on consumption of shocks on the current account, which is the most basic and traditional motive, even in the absence of international capital flows as a result or by - product of foreign market intervention to prevent exchange rate appreciation. this is usually defined as a “ mercantilist ” motive. as precaution against possible abrupt capital outflows ( the “ sudden stop ” syndrome ) the costs of holding reserves are also well identified : there is a direct opportunity cost because foreign exchange reserves ’ risk / return profile may be lower than for other, alternative, investments. finally, as reserves accumulate, countries are getting increasingly exposed to exchange rate risk and face the possibility of significant valuation losses. this traditional cost / benefit analysis seems less and less able, however, to account for the true behavior of reserve holders. during the crisis, foreign exchange reserves were used as a tool for internal – as well as external – financial stability. national central banks, especially in latin america, acted as dollar lenders of last resort to their domestic banks. ( obstfeld et al. 2009 ). this function will develop in the future. financial openness and integration means that domestic banks will engage more and more into foreign currency operations. in turn, the expansion of their international balance sheets will increase the potential demand for liquidity support in case of shocks. this trend should be accepted as a normal consequence of open capital markets and international banking, together with the predominance of a very limited number of currencies in international finance. it is bound to impact the demand for reserves and increase the need for self insurance. one characteristic of liquidity shocks is that the net demand for liquidity may become almost infinite. ex ante, no buffer is ever big enough. no amount of reserves will fully protect a financially open economy against a systemic shock. it is noticeable that countries, such as korea, which possessed very important amounts of reserves prior to the crisis and has a flexible exchange rate regime, nevertheless felt the need to enter into currency swaps with the federal reserve. in a sense, countries face the same dilemma as private institutions. they need liquid

##ity in times of stress but it is costly to hold in normal times. their reactions, however, are opposite. private institutions tend to underestimate their liquidity needs because, in case of shock, the central bank can step in as a lender of last resort. for countries, the bias goes in the other direction. provision of international liquidity, whether private or official, is contingent, conditional and uncertain. with no international lender of last resort, financial stability motives could lead to unlimited accumulation of liquidity. internationalisation of finance has created a fundamental indeterminacy in the demand for reserves. as a consequence, past benchmarks used to assess the adequacy of reserves are no longer valid. current research ( obstfeld et al. 2009 ) shows that broad domestic money aggregates may be the best explanatory factors for the amount of reserves. multilateral provision of international liquidity : the search for financial safety nets the rationale for a multilateral source of liquidity provision is straightforward : stabilizing the demand for international reserves would bring huge benefits in terms of world welfare. at the moment, reserve accumulation can only occur through a conjunction of balance of payment surplus and some degree of exchange rate intervention and creates externalities for other countries. now, suppose there is “ ex ante ” an existing pool of reserve assets which countries could tap into under specific circumstances. if access to this pool is credible and predictable, there would be no need for getting those reserves from the market. this would reduce the incentive for countries to conduct a whole set of policies such as : generating current account surpluses through active exchange rate management ring fencing pools of liquidity and capital in local subsidiaries, therefore creating a potential segmentation of international financial markets. implementing “ soft ” capital controls to limit the impact of shocks and diminish the need for reserves all countries, therefore have a common interest in finding ways to disconnect reserve accumulation from exchange rate management and, more generally, from balance of payment situations and monetary policies. the need for national reserves could be reduced if credible mechanisms exist to provide for the supply of official liquidity on a multilateral basis. significant progress has been achieved in this direction during the recent period. a dense network of forex swaps has been put into place between major central banks in the midst of the crisis. other recent official initiatives include : the creation by the imf of a new facility – the flexible credit line – aimed at easing liquid