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The optimal reserve level theory aims to protect the economy against external shocks to its balance of payments, providing the international liquidity needed in emergency situations. The methodological applications available have limitations that compromise the results of the analysis of the optimal level in Colombia. This article offers an alternative approach to optimal international reserves and a consistent methodological framework to overcome these limitations and add trust to the monetary authorities and international agents. [ABSTRACT FROM AUTHOR]

In the 20 years since 1969, international reserves have shown considerable increases, that seem to be far in excess of any long-term global need. This was a consequence of the prominent role that the dollar continued to play in the monetary system, which made it easy for the United States to finance balance of payments deficits in its own currency, increasing the amount of dollars in reserves. In addition the Eurodollar market made international reserves to some extent demand/determined: there was a very elastic supply of liquidity in this market. These developments in international reserves have inflationary consequences. To prevent such consequences in the future, central banks should set up a systematic surveillance system for international liquidity together with the IMF and BIS. An essential instrument in this context would be for the United States to finance its balance of payments deficits in foreign currencies in world capital markets. [ABSTRACT FROM AUTHOR]

The article presents a discussion on international liquidity. According to professor Peter B. Kenen, the stock of reserve assets is adequate, for now and for the foreseeable future. In Continental Europe, there is now probably a better equilibrium in the basic balance of payments between industrial countries than in recent years. A relative calm has descended on the foreign exchanges, and the short-term need for reserves has in a sense been reduced. Nevertheless, there are a number of considerations that argue against a too complacent view. The primary indicator of the desirability of larger or smaller international reserves is the deflation/inflation situation of the world, and particularly of those countries whose financial policies are likely to be influenced by the state of their reserves. The tendency to a decline in the propensity of countries to hold their reserves in the form of foreign exchange has occurred despite the possibly abnormally high level of the Canadian proportion of foreign exchange, the new willingness of the U.S. to hold foreign exchange reserves, the rather artificial increase in exchange reserves associated with bilateral swap transactions and the general restoration of confidence in the international exchanges.