Debt and International Reserves in Emerging Markets: Output Externalities or Precautionary Savings?

50 Pages Posted: 28 Sep 2020 Last revised: 16 Nov 2020

See all articles by Sang Seok Lee

Sang Seok Lee

Bilkent University

Paul Luk

Hong Kong Institute for Monetary and Financial Research

Ju Hyun Pyun

Korea University Business School (KUBS)

Date Written: November 1, 2020

Abstract

We study the joint behavior of external debt, international reserves, and the real interest rate based on a dynamic regime-switching small open economy model that incorporates the salient features of economic crises in emerging markets. Our model allows an assessment of the two well-known motives behind reserve accumulation: output externalities and precautionary savings against sudden stops. Using data from 24 emerging countries from 1970 to 2017, we estimate the model and show that both motives matter in many of our sample countries, with international reserves serving as an instrument to sustain higher levels of output and insure against disruptions from crises. The model is quantitatively successful at matching various aspects of the data that exhibit substantial variation across these countries. We also demonstrate that the contribution from output externalities is heterogeneous in direction and magnitude, which informs the debate concerning the two motives in the literature.

Keywords: Debt; International reserves; Small open economy model; Interest rate premium; Precautionary savings; Output externality; Regime-switching; Emerging market

JEL Classification: E21; E43; F32; F34; H63

Suggested Citation

Lee, Sang Seok and Luk, Paul and Pyun, Ju Hyun, Debt and International Reserves in Emerging Markets: Output Externalities or Precautionary Savings? (November 1, 2020). Available at SSRN: https://ssrn.com/abstract=3671609 or http://dx.doi.org/10.2139/ssrn.3671609

Sang Seok Lee (Contact Author)

Bilkent University ( email )

Bilkent, 06533
Turkey

Paul Luk

Hong Kong Institute for Monetary and Financial Research ( email )

Hong Kong

Ju Hyun Pyun

Korea University Business School (KUBS) ( email )

145 Anam-Ro, Seongbuk-Gu
Seoul, 02841
Korea, Republic of (South Korea)
82-2-3290-2610 (Phone)

HOME PAGE: http://sites.google.com/site/juhyunpyun/research

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