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A Macroprudential Theory of Foreign Reserve Accumulation

Author

Listed:
  • Fernando Arce
  • Julien Bengui
  • Javier Bianchi

Abstract

This paper proposes a theory of foreign reserves as macroprudential policy. We study an open-economy model of financial crises in which pecuniary externalities lead to overborrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross-section, and can quantitatively account for the recent upward trend in international reserves.

Suggested Citation

  • Fernando Arce & Julien Bengui & Javier Bianchi, 2019. "A Macroprudential Theory of Foreign Reserve Accumulation," Staff Working Papers 19-43, Bank of Canada.
    • Handle: RePEc:bca:bocawp:19-43
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    References listed on IDEAS

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    More about this item

    Keywords

    Balance of payments and components; Financial stability; Financial system regulation and policies; Foreign reserves management; International financial markets;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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