Reserve Accumulation, Macroeconomic Stabilization and Sovereign Risk

Javier Bianchi and Cesar Sosa-Padilla

No 1166, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We study the use of foreign reserves for macroeconomic stabilization purposes in a small open economy. Three key features characterize our model economy: (i) nominal rigidities, (ii) fixed exchange rates, and (iii) sovereign default risk. We argue that these features are prevalent in a large number of emerging economies. In this setup, reserve accumulation not only serves a precautionary role (hedging against roll-over risk) but it is also useful for macro-stabilization goals: in bad times, when aggregate demand is low, involuntary unemployment arises and output is low, the country can use (i.e. run down) its reserves to boost aggregate demand and output. We study the country’s optimal external portfolio composition (debt and reserves), how the stabilization property of reserves interacts with the typical precautionary role, and how this affects the country’s default incentives.

Date: 2018
New Economics Papers: this item is included in nep-dge, nep-mac and nep-opm
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Related works:
Journal Article: Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk (2024)
Working Paper: Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk (2020)
Working Paper: Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:1166

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