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Foreign Exchange Reserves in a Credit Constrained Economy

  • Kurmas Akdogan

    (Department of Economics, Mathematics & Statistics, Birkbeck)

We discuss the role of foreign exchange reserves as precautionary savings under an imperfect market framework due to the presence of endogenously determined borrowing constraints. We show that cost of holding reserves is higher in borrowing constrained economies than unconstrained ones as a result of the leverage effect of the debt. We also argue that high global reserve holdings can even be welfare reducing for the world economy where financially constrained developing countries are heavy borrowers in international lending markets.

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Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 1014.

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Date of creation: Sep 2010
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Handle: RePEc:bbk:bbkefp:1014
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