An FTPL Approach to International Reserve Accumulation

Countries around the world hold large stocks of reserves—on average 10% of GDP, with some countries holding as much as 90%. This paper examines the role of international reserve accumulation through the lens of the Fiscal Theory of the Price Level (FTPL). The main insights are as follows. First, for a given level of net debt, issuing reserves against nominal debt modifies the government’s asset base, increasing the stock of liabilities that can be devalued via price-level movements. A high stock of reserves therefore reduces inflation volatility stemming from fiscal shocks. Second, for a given stock of reserves, the greater the equilibrium elasticity of the exchange rate to domestic inflation, the stronger the valuation effects on foreign-currency assets, which help stabilize prices and the exchange rate by affecting net debt. However, these valuation effects are double-edged: a positive stock of international reserves also influences the transmission of foreign nominal (inflation and currency) shocks. In addition to providing a rationale for foreign exchange interventions, nominal-to-real spillovers raise issues in fiscal and monetary policy design.