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International Reserve Holdings with Sovereign Risk and Costly Tax Collection

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Author Info
Joshua Aizenman (University of California, Santa Cruz)
Nancy Marion (Dartmouth College)

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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 behavior 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 behavior, a policy recommendation to increase international reserve holdings may be welfare-reducing.

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Paper provided by Center for International Economics, UC Santa Cruz in its series Santa Cruz Center for International Economics, Working Paper Series with number 1014.

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Date of creation: 01 Nov 2003
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Handle: RePEc:cdl:scciec:1014

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Keywords: intertemporal consumption and distortion smoothing; political instability; corruption;

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  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)
  2. Hipple, F Steb, 1979. "A Note on the Measurement of the Holding Cost of International Reserves," The Review of Economics and Statistics, MIT Press, vol. 61(4), pages 612-14, November. [Downloadable!] (restricted)
  3. 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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  4. 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)
  5. 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)
  6. 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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  7. 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)
  8. Hamid Reza Davoodi & Vito Tanzi, 1997. "Corruption, Public Investment, and Growth," IMF Working Papers 97/139, International Monetary Fund.
  9. Edwards, Sebastian, 1985. "On the interest-rate elasticity of the demand for international reserves: Some evidence from developing countries," Journal of International Money and Finance, Elsevier, vol. 4(2), pages 287-295, June. [Downloadable!] (restricted)
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  10. Bahmani-Oskooee, Mohsen, 1985. "Demand for International Reserves: Survey of Recent Empirical Studies," Applied Economics, Taylor and Francis Journals, vol. 17(2), pages 359-75, April.
  11. 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)
  12. Detragiache, Enrica, 1996. "Fiscal Adjustment and Official Reserves in Sovereign Debt Negotiations," Economica, London School of Economics and Political Science, vol. 63(249), pages 81-95, February. [Downloadable!] (restricted)
  13. 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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