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Foreign Reserve Accumulation, Foreign Direct Investment, and Economic Growth

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  • Hidehiko Matsumoto

    (Economist, Institute for Monetary and Economic Studies, Bank of Japan (E-mail: hidehiko.matsumoto@boj.or.jp))

Abstract

This paper develops a quantitative small-open-economy model to assess the optimal pace of foreign reserve accumulation by emerging and developing countries. In the model, reserve accumulation depreciates the real exchange rate and attracts foreign direct investment (FDI) inflows, which promotes productivity growth through endogenous firm dynamics. The economy is also subject to sudden stops in the form of an occasionally binding constraint on foreign borrowing, and accumulated reserves are used to prevent severe economic downturns. The model shows that two factors are the key determinants of the optimal pace of reserve accumulation: the elasticity of the foreign borrowing spread with respect to foreign debt, and the entry cost for FDI entry. The model suggests that these two factors can explain a substantial amount of the cross-country variation in the observed pace of reserve accumulation.

Suggested Citation

  • Hidehiko Matsumoto, 2019. "Foreign Reserve Accumulation, Foreign Direct Investment, and Economic Growth," IMES Discussion Paper Series 19-E-04, Institute for Monetary and Economic Studies, Bank of Japan.
    • Handle: RePEc:ime:imedps:19-e-04
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    3. Lutz, Flora & Zessner-Spitzenberg, Leopold, 2020. "Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk," VfS Annual Conference 2020 (Virtual Conference): Gender Economics 224520, Verein für Socialpolitik / German Economic Association.
    4. Corsetti, G. & Maeng, S. H., 2023. "The Theory of Reserve Accumulation, Revisited," Janeway Institute Working Papers 2319, Faculty of Economics, University of Cambridge.
    5. Corsetti, G. & Maeng, S. H., 2023. "The Theory of Reserve Accumulation, Revisited," Cambridge Working Papers in Economics 2370, Faculty of Economics, University of Cambridge.
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    More about this item

    Keywords

    Foreign Reserve Accumulation; Foreign Direct Investment; Sudden Stops; Endogenous Growth; Real Exchange Rate; Gross Capital Flows;
    All these keywords.

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies

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