International Reserve Holdings with Sovereign Risk and Costly Tax Collection

23 Pages Posted: 16 Sep 2011

See all articles by Joshua Aizenman

Joshua Aizenman

National Bureau of Economic Research (NBER)

Nancy Peregrim Marion

Dartmouth College - Department of Economics

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Date Written: July 2004

Abstract

We derive a precautionary demand for international reserves in the presence of sovereign risk and show that political‐economy considerations modify the optimal level of reserve holdings. A greater chance of opportunistic behaviour by future policy makers and political corruption reduce the demand for international reserves and increase external borrowing. We provide evidence to support these findings. Consequently, the debt‐to‐reserves ratio may be less useful as a vulnerability indicator. A version of the Lucas Critique suggests that if a high debt‐to‐reserves ratio is a symptom of opportunistic behaviour, a policy recommendation to increase international reserve holdings may be welfare‐reducing.

Suggested Citation

Aizenman, Joshua and Marion, Nancy P., International Reserve Holdings with Sovereign Risk and Costly Tax Collection (July 2004). The Economic Journal, Vol. 114, Issue 497, pp. 569-591, 2004, Available at SSRN: https://ssrn.com/abstract=1928420 or http://dx.doi.org/10.1111/j.1468-0297.2004.00232.x

Joshua Aizenman (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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Nancy P. Marion

Dartmouth College - Department of Economics ( email )

Hanover, NH 03755
United States
(603) 646-2511 (Phone)

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