Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk

42 Pages Posted: 9 Jun 2020

See all articles by Javier Bianchi

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

César Sosa‐Padilla

University of Notre Dame

Date Written: June 2020

Abstract

In the past three decades, governments in emerging markets have accumulated large amounts of international reserves, especially those with fixed exchange rates. We propose a theory of reserve accumulation that can account for these facts. Using a model of endogenous sovereign default with nominal rigidities, we show that the interaction between sovereign risk and aggregate demand amplification generates a macroeconomic-stabilization hedging role for international reserves. Reserves increase debt sustainability to such an extent that financing reserves with debt accumulation may not necessarily lead to increases in spreads. We also study simple and implementable rules for reserve accumulation. Our findings suggest that a simple linear rule linked to spreads can achieve significant welfare gains, while those rules currently used in policy studies of reserve adequacy can be counterproductive.

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Suggested Citation

Bianchi, Javier and Sosa‐Padilla, César, Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk (June 2020). NBER Working Paper No. w27323, Available at SSRN: https://ssrn.com/abstract=3621829

Javier Bianchi (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

César Sosa‐Padilla

University of Notre Dame

361 Mendoza College of Business
Notre Dame, IN 46556-5646
United States

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