Working Paper: NBER ID: w26236
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: foreign reserves; macroprudential policy; financial crises; overborrowing; capital flows
JEL Codes: E0; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| private external debt growth (F34) | reserve growth (D25) |
| openness of capital accounts (F32) | reserve levels (E58) |
| government reserve accumulation (H60) | reduced financial crisis exposure (F65) |
| government reserve accumulation (H60) | increase in gross private borrowing (F65) |
| government reserve accumulation (H60) | improvement in economy's net foreign asset position (F32) |