Working Paper: CEPR ID: DP13952
Authors: 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.
Keywords: macroprudential policy; international reserves; financial crises
JEL Codes: D52; D62; F24; F38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Accumulating international reserves (F30) | Decrease in vulnerability to financial crises (F65) |
| Accumulating international reserves (F30) | Increase in gross private borrowing (F65) |
| Accumulating international reserves (F30) | Improvement in net foreign asset position (F32) |
| Accumulating international reserves (F30) | Private external debt (F34) |
| Less financial regulation (G18) | Accumulating more reserves (F31) |