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International Reserve Holdings with Sovereign Risk and Costly Tax Collection

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Joshua Aizenman
Nancy Marion

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Abstract

We derive a precautionary demand for international reserves in the presence of sovereign risk and show that political-economy considerations modify the optimal level of reserve holdings. A greater chance of opportunistic behaviour by future policy makers and political corruption reduce the demand for international reserves and increase external borrowing. We provide evidence to support these findings. Consequently, the debt-to-reserves ratio may be less useful as a vulnerability indicator. A version of the Lucas Critique suggests that if a high debt-to-reserves ratio is a symptom of opportunistic behaviour, a policy recommendation to increase international reserve holdings may be welfare-reducing. Copyright 2004 Royal Economic Society.

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Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 114 (2004)
Issue (Month): 497 (07)
Pages: 569-591
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Handle: RePEc:ecj:econjl:v:114:y:2004:i:497:p:569-591

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October. [Downloadable!] (restricted)
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  2. Alex Cukierman & Sebastian Edwards & Guido Tabellini, 1989. "Seigniorage and Political Instability," NBER Working Papers 3199, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Ben-Bassat, Avraham & Gottlieb, Daniel, 1992. "Optimal international reserves and sovereign risk," Journal of International Economics, Elsevier, vol. 33(3-4), pages 345-362, November. [Downloadable!] (restricted)
  4. Frenkel, Jacob A & Jovanovic, Boyan, 1981. "Optimal International Reserves: A Stochastic Framework," Economic Journal, Royal Economic Society, vol. 91(362), pages 507-14, June. [Downloadable!] (restricted)
  5. Joshua Aizenman, Michael Gavin, Ricardo Hausmann, 2000. "Optimal tax and debt policy with endogenously imperfect creditworthiness," Journal of International Trade & Economic Development, Taylor and Francis Journals, vol. 9(4), pages 367-395, December. [Downloadable!] (restricted)
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  6. Lizondo, JoseSaul & Mathieson, Donald J., 1987. "The stability of the demand for international reserves," Journal of International Money and Finance, Elsevier, vol. 6(3), pages 251-282, September. [Downloadable!] (restricted)
  7. Hamid Reza Davoodi & Vito Tanzi, 1997. "Corruption, Public Investment, and Growth," IMF Working Papers 97/139, International Monetary Fund.
  8. Alesina, Alberto & Tabellini, Guido, 1990. "A Positive Theory of Fiscal Deficits and Government Debt," Review of Economic Studies, Blackwell Publishing, vol. 57(3), pages 403-14, July. [Downloadable!] (restricted)
  9. Eaton, Jonathan & Gersovitz, Mark, 1980. "LDC participation in international financial markets : Debt and reserves," Journal of Development Economics, Elsevier, vol. 7(1), pages 3-21, February. [Downloadable!] (restricted)
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