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Reserve Accumulation, Macroeconomic Stabilization and Sovereign Risk

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  • Javier Bianchi

    (Federal Reserve Bank of Minneapolis)

  • Cesar Sosa-Padilla

    (Notre Dame)

Abstract

We study the use of foreign reserves for macroeconomic stabilization purposes in a small open economy. Three key features characterize our model economy: (i) nominal rigidities, (ii) fixed exchange rates, and (iii) sovereign default risk. We argue that these features are prevalent in a large number of emerging economies. In this setup, reserve accumulation not only serves a precautionary role (hedging against roll-over risk) but it is also useful for macro-stabilization goals: in bad times, when aggregate demand is low, involuntary unemployment arises and output is low, the country can use (i.e. run down) its reserves to boost aggregate demand and output. We study the country’s optimal external portfolio composition (debt and reserves), how the stabilization property of reserves interacts with the typical precautionary role, and how this affects the country’s default incentives.

Suggested Citation

  • Javier Bianchi & Cesar Sosa-Padilla, 2018. "Reserve Accumulation, Macroeconomic Stabilization and Sovereign Risk," 2018 Meeting Papers 1166, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:1166
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    Cited by:

    1. Fang, Xiang & Hardy, Bryan & Lewis, Karen K., 2022. "Who Holds Sovereign Debt and Why It Matters," CEPR Discussion Papers 17338, C.E.P.R. Discussion Papers.
    2. Khan, Muhammad Tariq Iqbal & Anwar, Sofia, 2022. "Natural disasters and foreign exchange reserves: The role of renewable energy and human capital," Renewable Energy, Elsevier, vol. 192(C), pages 838-848.
    3. Johri, Alok & Khan, Shahed & Sosa-Padilla, César, 2022. "Interest rate uncertainty and sovereign default risk," Journal of International Economics, Elsevier, vol. 139(C).
    4. Thibault Laurentjoye, 2022. "Foreign exchange reserves, imperfect substitutability of financial assets and the monetary policy quadrilemma," Working Papers PKWP2222, Post Keynesian Economics Society (PKES).
    5. Samano, Agustin, 2022. "International reserves and central bank independence," Journal of International Economics, Elsevier, vol. 139(C).
    6. Lutz, Flora & Zessner-Spitzenberg, Leopold, 2023. "Sudden stops and reserve accumulation in the presence of international liquidity risk," Journal of International Economics, Elsevier, vol. 141(C).
    7. Javier Bianchi & Guido Lorenzoni, 2021. "The Prudential Use of Capital Controls and Foreign Currency Reserves," NBER Working Papers 29476, National Bureau of Economic Research, Inc.
    8. Javier Bianchi & Jorge Mondragon, 2022. "Monetary Independence and Rollover Crises," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 137(1), pages 435-491.
    9. Alexander Mihailov, 2022. "Editorial – Recent Trends in International Reserves: Theory and Evidence," Open Economies Review, Springer, vol. 33(5), pages 807-815, November.
    10. Sosa-Padilla, César & Sturzenegger, Federico, 2023. "Does it matter how central banks accumulate reserves? Evidence from sovereign spreads," Journal of International Economics, Elsevier, vol. 140(C).
    11. Alexander Mihailov & Harun Nasir, 2022. "Sudden Stops, Productivity and the Optimal Level of International Reserves for Small Open Economies," Open Economies Review, Springer, vol. 33(5), pages 825-851, November.
    12. Bianchi, Javier & Sosa-Padilla, César, 2024. "On wars, sanctions, and sovereign default," Journal of Monetary Economics, Elsevier, vol. 141(C), pages 62-70.
    13. Javier Bianchi, 2022. "The Research Agenda: Javier Bianchi on Financial Crises and Prudential Policies," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 23(1), April.
    14. Liu, Siming & Ma, Chang & Shen, Hewei, 2024. "Sudden stop with local currency debt," Journal of International Economics, Elsevier, vol. 148(C).

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    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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