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Reserve accumulation, growth and financial crises

Benigno, Gianluca and Fornaro, Luca (2012) Reserve accumulation, growth and financial crises. CEP Discussion Papers, CEPDP1161. Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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Abstract

We present a model that reproduces two salient facts characterizing the international monetary system: i) Faster growing countries are associated with lower net capital inflows and ii) Countries that grow faster accumulate more international reserves and receive more net private inflows. We study a two-sector, tradable and non-tradable, small open economy. There is a growth externality in the tradable sector and agents have imperfect access to international financial markets. By accumulating foreign reserves, the government induces a real exchange rate depreciation and a reallocation of production towards the tradable sector that boosts growth. Financial frictions generate imperfect substitutability between private and public debt flows so that private agents do not perfectly offset the government policy. The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth. We use the model to compare the laissez-faire equilibrium and the optimal reserve policy in an economy that is opening to international capital flows. We find that the optimal reserve management entails a fast rate of reserve accumulation, as well as higher growth and larger current account surpluses compared to the economy with no policy intervention. We also find that the welfare gains of reserve policy are large, in the order of 1 percent of permanent consumption equivalent.

Item Type: Monograph (Discussion Paper)
Official URL: http://cep.lse.ac.uk/_new/publications/series.asp?...
Additional Information: © 2012 The Authors
Library of Congress subject classification: H Social Sciences > HB Economic Theory
Journal of Economic Literature Classification System: F - International Economics > F3 - International Finance > F31 - Foreign Exchange
F - International Economics > F3 - International Finance > F32 - Current Account Adjustment; Short-Term Capital Movements
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F43 - Economic Growth of Open Economies
Sets: Departments > Economics
Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Identification Number: CEPDP1161
Date Deposited: 07 Aug 2013 13:41
URL: http://eprints.lse.ac.uk/51506/

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