Money supply growth is what eventually drives inflation. In this note, we examine how changes in foreign exchange reserves and money supply are interrelated in the economy. We seek to demonstrate that even though foreign exchange reserve purchasing by a central bank has no direct effect on the dynamics of money supply or credit as long as an efficient bank liquidity management mechanism is in place, its indirect effects may be substantial. They are reflected in changes in the balance of payments (an increase in current account surplus and (or) an inflow of capital into the non-banking sector) and an increase in risk taking in the banking sector.