Under the gold-exchange standard, national currencies have supplemented gold as an international means of payment. The extent to which the fiduciary component of international reserves can be expanded depends on the reserve policies of central banks. Investigation of these policies is essential in assessing the adequacy of international reserves and the urgency of reducing the U.S. balance of payments deficit. Therefore, in this paper, we extend and test Kenen's model on reserve policies of central banks [4] and show its implications for U.S. balance of payments policy.'

The comment of John Makin gives me an opportuinitv to elaborate on some of the implications the existence of a second reserve currency might have in the model and the empirical tests. In the model in Part I, we have assumed that there are only two reserve assets, gold and one reserve currency (dollars), and investigated what economic factors might determine the reserve policies of central banks. Of these factors, some characterize the country in question, others characterize the reserve-currency country (United States), and again, others the relation between them. If a second reserve currency (sterling) is introduced into the model, additional variables come into play which reflect the economic position of the second reserve-currency coun try (United Kingdom), its relation to the specific country as well as its relative position to the first reserve-currency country. Thus, if a country can hold pounds in addition to gold and dollars, it might rearrange