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Reserve Accumulation, Growth and Financial Crises

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  • Benigno, Gianluca
  • Fornaro, Luca

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. This generates a positive link between reserve accumulation, growth and current account surpluses. 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% of permanent consumption equivalent.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9224.

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Date of creation: Nov 2012
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Handle: RePEc:cpr:ceprdp:9224

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

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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. Coeurdacier, Nicolas & Guibaud, Stéphane & Jin, Keyu, 2012. "Credit Constraints and Growth in a Global Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9109, C.E.P.R. Discussion Papers.
  2. Cheng, G., 2013. "A Growth Perspective on Foreign Reserve Accumulation," Working papers, Banque de France 443, Banque de France.
  3. Bacchetta, P. & Benhima, K. & Kalantzis, Y., 2013. "Optimal Exchange Rate Policy in a Growing Semi-Open Economy," Working papers, Banque de France 452, Banque de France.
  4. Gianluca Benigno & Luca Fornaro, 2013. "The Financial Resource Curse," CEP Discussion Papers dp1217, Centre for Economic Performance, LSE.
  5. Steiner, Andreas, 2014. "Current account balance and dollar standard: Exploring the linkages," Journal of International Money and Finance, Elsevier, Elsevier, vol. 41(C), pages 65-94.
  6. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2013. "International reserves and rollover risk," Working Paper, Federal Reserve Bank of Richmond 13-01, Federal Reserve Bank of Richmond.
  7. Laura Alfaro & Fabio Kanczuk, 2013. "Carry Trade, Reserve Accumulation, and Exchange-Rate Regimes," NBER Working Papers 19098, National Bureau of Economic Research, Inc.
  8. Martin Berka & Michael B. Devereux, 2013. "Trends in European real exchange rates," Economic Policy, CEPR;CES;MSH, CEPR;CES;MSH, vol. 28(74), pages 193-242, 04.
  9. 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.

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