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Accumulation of Foreign Exchange Reserves and Long Term Growth

Listed author(s):
  • Polterovich, Victor
  • Popov, Vladimir

Cross-country regressions, reported in this paper for 1960-99 period, seem to suggest that the accumulation of foreign exchange reserves (FER) contributes to economic growth of a developing economy by increasing both the investment/GDP ratio and capital productivity. We offer the following interpretation of these stylized facts: (1) FER accumulation causes real exchange rate (RER) undervaluation that is expansionary in the short run and may have long term effects, if such devaluations are carried out periodically and unexpectedly; (2) RER undervaluation allows to take full advantages of export externality and triggers export-led growth; (3) FER build up attracts foreign direct investment because it increases the credibility of the government of a recipient country and lowers the dollar price of real assets. A three-sector model of endogenous economic growth (including a consumer good sector, investment good sector and an export trade sector) is suggested to demonstrate how undervaluation may improve social welfare. Concepts of FER accumulation trajectories and equilibrium trajectories are introduced. It is demonstrated that small udervaluation of the equilibrium exchange rate may be wealth improving.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20069.

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Date of creation: 2003
Handle: RePEc:pra:mprapa:20069
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  1. Dollar, David, 1992. "Outward-Oriented Developing Economies Really Do Grow More Rapidly: Evidence from 95 LDCs, 1976-1985," Economic Development and Cultural Change, University of Chicago Press, vol. 40(3), pages 523-544, April.
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  10. Steven B. Kamin & John H. Rogers, 1997. "Output and the real exchange rate in developing countries: an application to Mexico," International Finance Discussion Papers 580, Board of Governors of the Federal Reserve System (U.S.).
  11. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers 191, Massachusetts Institute of Technology (MIT), Department of Economics.
  12. Jens Holscher, 1997. "Economic dynamism in transition economies: Lessons from Germany," Post-Communist Economies, Taylor & Francis Journals, vol. 9(2), pages 173-181.
  13. Charles Engel, 2000. "Optimal Exchange Rate Policy:The Influence of Price-Setting and Asset Markets," Discussion Papers in Economics at the University of Washington 0020, Department of Economics at the University of Washington.
  14. Buffie, Edward F., 1986. "Devaluation, investment and growth in LDCs," Journal of Development Economics, Elsevier, vol. 20(2), pages 361-379, March.
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  16. Polterovich, Victor, 2007. "Institutional Trap," MPRA Paper 20595, University Library of Munich, Germany.
  17. Polterovich, Victor & Popov, Vladimir, 2005. "Appropriate Economic Policies at Different Stages of Development," MPRA Paper 20066, University Library of Munich, Germany.
  18. Morley, Samuel A, 1992. "On the Effect of Devaluation during Stabilization Programs in LDCs," The Review of Economics and Statistics, MIT Press, vol. 74(1), pages 21-27, February.
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