International reserves management and capital mobility in a volatile world: Policy considerations and a case study of Korea

This paper characterizes the precautionary demand for international reserves driven by the attempt to
reduce the incidence of costly output decline induced by sudden reversal of short-term capital flows. It
validates the main predictions of the precautionary approach by investigating changes in the patterns of
international reserves in Korea in the aftermath of the 1997–1998 crisis. This crisis provides an interesting
case study, especially because of the rapid rise in Korea’s financial integration in the aftermath of the East
Asian crisis, where foreigners’ shareholding has increased to 40% of total Korean market capitalization.We
show that the crisis led to structural change in the hoarding of international reserves, and that the Korean
monetary authority gives much greater attention to a broader notion of ‘hot money,’ inclusive of short-term
debt and foreigners’ shareholding. J. Japanese Int. Economies 21 (1) (2007) 1–15. UCSC and the NBER
Economics, 1156 High Street, Santa Cruz, CA 95064, USA; Economics Department, Chungbuk National
University, Republic of Korea; Economics Department, Sookmyung Women’s University, Republic of Korea.