Why are reserves necessary in the international financial system?

Expert Answers info

pohnpei397 eNotes educator | Certified Educator

calendarEducator since 2009

write35,413 answers

starTop subjects are History, Literature, and Social Sciences

Countries tend to keep reserves (when they can) so as to be able to affect the exchange rate for their own currencies.  Without reserves, governments would have a much harder time affecting these rates.

Let's say, for example, that a country feels its currency is getting too weak against the dollar.  The country might not like this because oil prices are denominated in dollars and a weak currency means oil prices effectively go up.  In such a case, the country would take some of its reserves and use them to buy its currency on the open market.  This would lower the supply of its currency and, it hopes, drive up its price relative to the dollar.

check Approved by eNotes Editorial

Unlock This Answer Now