The massive accumulation of international reserves in developing economies is
one of the most puzzling recent developments in the world economy. This paper
argues that it can be explained by a simple model in which the central bank smooths
in‡ation and stabilizes the exchange rate. I explore the view that reserve accumu-
lation is the consequence of an increase in the incidence and magnitude of banking
crises. These crises impose exceptional costs that need to be …nanced with in‡ation
related revenues. In‡ation is distortionary. As a result, the central bank optimally
accumulates international reserves in order to spread the distortions associated with
in‡ation over time. A quantitative exercise for an average developing economy using
data between 1970 and 2007 predicts long-run levels of reserves that coincide with
average holdings in developing economies. Furthermore, the monetary perspective
studied in this paper sheds light on the determinants of cross-sectional variation in
reserve holdings.

Link to the paper: http://www.econ.upf.edu/eng/graduates/gpem/jm/pdf/paper/JMP%20Pina.pdf