Drift control of international reserves

We develop a model of optimal reserve holdings where the reserve authority controls the upward and downward drift of international reserves and chooses the trigger points that induce changes in drift. We argue that this drift control model better describes the dynamic behavior of reserves than does the popular buffer stock model. We present an innovative mathematical tool for analyzing the drift control based on martingale stopping theory. Since the reserve authority has more instruments with drift control than with a buffer-stock strategy, it can manage reserves at significantly lower cost.