Low interest rate policy and the use of reserve requirements in emerging markets

• This paper sheds light on the link between monetary policy in large economies with international currencies (the United States and the Euro Area) and the use of reserve requirements in emerging markets.
• We provide evidence that emerging markets tend to raise reserve requirements when interest rates in advanced economies with major funding and reserve currencies decline.
• Our findings suggest that reserve requirements are most likely used as financial stability tool in emerging markets.

This paper sheds light on the link between the interest rate policy in large advanced economies with international funding and reserve currencies (the United States and the euro area) and the use of reserve requirements in emerging markets. Using reserve requirement data for 28 emerging markets from 1998 to 2012, we provide evidence that emerging market central banks tend to raise reserve requirements when interest rates in international funding markets decline or financial inflows accelerate, most likely to preserve financial stability. In contrast, when global liquidity risk rises and funding from the large advanced economies dries up, emerging markets lower reserve requirements.