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Reserve Accumulation, Growth and Financial Crises

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  • Gianluca Benigno
  • Luca Fornaro

Abstract

We present a model that reproduces two salient facts characterizing the international monetary system: i) Faster growing countries are associated with lower net capital inflows and ii) Countries that grow faster accumulate more international reserves and receive more net private inflows. We study a two-sector, tradable and non-tradable, small open economy. There is a growth externality in the tradable sector and agents have imperfect access to international financial markets. By accumulating foreign reserves, the government induces a real exchange rate depreciation and a reallocation of production towards the tradable sector that boosts growth. Financial frictions generate imperfect substitutability between private and public debt flows so that private agents do not perfectly offset the government policy. The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth. We use the model to compare the laissez-faire equilibrium and the optimal reserve policy in an economy that is opening to international capital flows. We find that the optimal reserve management entails a fast rate of reserve accumulation, as well as higher growth and larger current account surpluses compared to the economy with no policy intervention. We also find that the welfare gains of reserve policy are large, in the order of 1 percent of permanent consumption equivalent.

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Bibliographic Info

Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1161.

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Date of creation: Aug 2012
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Handle: RePEc:cep:cepdps:dp1161

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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Keywords: foreign reserve accumulation; gross capital flows; growth; financial crises;

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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Capital Controls, Currency Wars, and International Cooperation
    by Blog Author in Liberty Street Economics on 2013-05-13 11:00:00
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Cited by:
  1. Keyu Jin & Stéphane Guibaud & Nicolas Coeurdacier, 2011. "Credit constraints and growth in a global economy," LSE Research Online Documents on Economics 35706, London School of Economics and Political Science, LSE Library.
  2. Gianluca Benigno & Luca Fornaro, 2013. "The financial resource curse," LSE Research Online Documents on Economics 51557, London School of Economics and Political Science, LSE Library.
  3. Bonatti, Luigi & Fracasso, Andrea, 2014. "Modeling the Transition Towards Renminbi's Full Convertibility: Implications for China’s Growth," MPRA Paper 54129, University Library of Munich, Germany.
  4. Bacchetta, P. & Benhima, K. & Kalantzis, Y., 2013. "Optimal Exchange Rate Policy in a Growing Semi-Open Economy," Working papers 452, Banque de France.
  5. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2013. "International Reserves and Rollover Risk," IMF Working Papers 13/33, International Monetary Fund.
  6. Cheng, G., 2013. "A Growth Perspective on Foreign Reserve Accumulation," Working papers 443, Banque de France.
  7. Martin Berka & Michael B. Devereux, 2013. "Trends in European real exchange rates," Economic Policy, CEPR & CES & MSH, vol. 28(74), pages 193-242, 04.
  8. Laura Alfaro & Fabio Kanczuk, 2013. "Carry Trade, Reserve Accumulation, and Exchange-Rate Regimes," NBER Working Papers 19098, National Bureau of Economic Research, Inc.
  9. Steiner, Andreas, 2014. "Current account balance and dollar standard: Exploring the linkages," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 65-94.

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