A Joint Adjustment Model of Money Stock and Foreign Reserves: Evidence for Korea & Japan

This study examines the partial adjustment model of foreign reserve holdings first developed by Kim(1983) and provides empirical evidence supporting the cases for Korea and Japan. The theoretical model we consider in this study is a variation of the monetary approach to the balance of payments. Kim asserts that changes in the foreign reserve holdings are a reflection of the optimizing behavior of the public at large and at the same time of the nation’s central bank. This is a single-equation model and is specified in terms of excess demand for money stock and the excess demand for foreign reserves. In this study we attempt to test the hypothesis that foreign reserve holding is the result of jointly achieving the desired levels of money demand and foreign reserve demand taking Japan and Korea. Through empirical analysis, we find that the Korean central bank’s behavior with respect to reserve demand is a bit more apparent than Japan during the sample period. With respect to excess money demand, however, theJapanese pubic seems to be more proactive than the Korean public. This result is consistent with the fact that the Japanese yen is a reserve currency whereas the Korean won is not.