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Foreign Reserve Accumulation, Foreign Direct Investment, and Economic Growth

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  • Hidehiko Matsumoto

    (GRIPS)

Abstract

This paper develops a quantitative small-open-economy model to study the determinants of the optimal pace of foreign reserve accumulation by developing countries. In the model, reserve accumulation depreciates the real exchange rate and attracts foreign direct investment (FDI) inflows, which promotes productivity growth through endogenous firm dynamics. The economy is also subject to sudden stops in the form of an occasionally binding constraint on foreign borrowing, and accumulated reserves are used to prevent severe economic downturns. The model shows that two factors are the key determinants of the optimal pace of reserve accumulation: the elasticity of the foreign borrowing spread with respect to foreign debt and the entry cost for FDI. The model suggests that these two factors can explain a substantial amount of the cross-country variation in the observed pace of reserve accumulation. (Copyright: Elsevier)

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  • Hidehiko Matsumoto, 2022. "Foreign Reserve Accumulation, Foreign Direct Investment, and Economic Growth," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 43, pages 241-262, January.
    • Handle: RePEc:red:issued:19-52
    DOI: 10.1016/j.red.2021.02.002
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    More about this item

    Keywords

    Endogenous growth; Real exchange rate; Gross capital flows;
    All these keywords.

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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