Abstract This paper examines the role of foreign exchange reserve demand in mitigating inflationary pressures resulting from money supply growth in reserve currency issuing states (RCISs). Despite recurrent substantial monetary expansions in RCISs in response to recessions such as the 2000 Post-Dot Com Bubble, the 2008 Great Recession, and the 2020 Covid-19 pandemic-induced recession, RCISs have not experienced commensurate inflation. Within the framework of the Quantity Theory of Money (QTM), factors such as economic slowdown and reduction in the velocity of money may contribute to dampening inflationary pressure that stems from money supply growth; however, GDP slowdowns have not explained the disproportionally low inflation in RCISs compared to their monetary expansions, and the impact of reduction in the velocity on lowering inflation remains unclear due to limited real-world data. In contrast, there is reliable data for foreign exchange reserve demand, characterized by currency exports in exchange for real economic resources of equivalent value. By analyzing the relationship between money supply growth, foreign exchange reserve demand, and inflation within the framework of QTM, this paper introduces the foreign exchange reserve demand-inflation buffer hypothesis. The theoretical and empirical investigation sheds light on the role of foreign exchange reserve demand in moderating inflationary pressures in RCISs. 124 Journal of Central Banking Theory and Practice their imports or foreign assets purchases with the international seigniorage gains accruing from the expansion of international reserves held in their currencies. Osman (2023a) discussed how fiat reserve currencies yield imperial rents to their issuing states and by using the QTM he provided a method to estimate the cumu- lative quantity of this rent using the tenets of the QTM and he estimated that in the period 1971-2021, the cumulative rent for the US Dollar, the Euro, the British Pound Sterling, and the Japanese Yen amounted to ~11.1 trillion USD. A paper released by the European Central Bank (2019) confirmed the existence of an ex - orbitant privilege that benefits all reserve currencies issuing states by lowering government borrowing costs and estimated that the term premiums on govern - ment bonds are reduced by 0.93 for the U.S, 0.13 for Japan, 0.74 for the U.K, and 1.38 for the euro area. The benefits enjoyed by the RCISs are the ability to borrow in their currencies, which entails lower borrowing costs, the existence of a high level of immunity against the balance of payment shocks, maintaining low inter- est rates which is a stimulus to economic activity, and giving a competitive edge which the financial institutions, firms, and consumers of RCISs hold over their counterparts in non-reserve currency issuing states (NRCISs) in international and domestic markets. While the literature emphasized the exorbitant privilege of reserve currency as the ability to achieve international seigniorage, and the low borrowing costs asso- ciated with the massive capital inflows to RCISs due to the reserve status of their currencies, the literature has not adequately investigated the role of reserve cur - rency status in mitigating inflationary pressures that result from excess money supply growth. Particularly, the literature has bypassed analyzing the fact that foreign exchange reserve demand, through its effect on the local money supply and income, may provide an inflation buffer against excess money supply growth in RCISs. As Table 1 shows, the amounts of the allocated worldwide official holdings of for- eign exchange reserves are colossal. The amount of the 135 Introducing the Foreign Exchange Reserve Demand – Inflation Buffer Hypothesis P2r < P 2, as = (M2r * V) / (Yr) < M2 * V/Y, as (M2 - R) * V/(Y + R) < M2 * V/Y and the inflation rate in the reserve currency condition would always be less than the inflation rate in the non-reserve currency condition since: Π2 < Π1, as (P2r - P1) / P1 < (P2 - P1) / P1 since P2r < P 2 The algebraic modelling of the Quantity Theory of Money with the incorporation of foreign exchange reserve demand shows that in the reserve currency condi - tion, the price level (P2r), and consequentially inflation (Π2r), are affected not only by changes in the money supply, output shocks, and the velocity of money, but also by changes in the demand for the reserve currency through its effect on the money supply and income via transfers of real output from abroad. Therefore, if the demand for the reserve currency increases, it offsets the inflationary effects of a given increase in the money supply, thereby mitigating inflation. While 6 it holds true that the majority of reserve currency acquisitions swiftly re-enter the circulation of reserve currency-issuing states, it is imperative to de - lineate that this re-entry takes place in the form of capital investment, which falls within the purview of the 'investment' component in Gross Domestic Product (GDP) calculations. This capital infusion assumes various forms, encompassing investments in debt instruments such as treasury securities, acquisitions of eq - uities in the private sector, ventures in Foreign Direct Investment (FDI), and in other investment asset classes. Consequently, the reintroduction of currency into the economies of reserve currency-issuing states engenders an expansion of both the monetary base (M) and economic output (Y) in direct proportion. Within the framework of the equilibrium equation denoted as P = M.V/Y, the price level (P) remains unchanged. Hence, the inflation buffer provided by foreign exchange reserve demand expected to remain intact. 4. Examining the Reserve Demand’s Inflation Buffer Through Econometric Analysis This segment provides an econometric analysis to determine whether the influ - ence of reserve demand on inflation in RCISs is significant. 6 Clarification for footnote 5.