TY  - JOUR
AU  - Aizenman,Joshua
AU  - Marion,Nancy P.
TI  - International Reserve Holdings with Sovereign Risk and Costly Tax Collection
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 9154
PY  - 2002
Y2  - September 2002
UR  - http://www.nber.org/papers/w9154
L1  - http://www.nber.org/papers/w9154.pdf
N1  - Author contact info:
Joshua Aizenman
Department of Economics;  E2
1156 High St.
University of California, Santa Cruz
Santa Cruz, CA  95064
Tel: 831/459-4791
Fax: 831/459-5077
E-Mail: jaizen@ucsc.edu

Nancy Marion
Department of Economics
Dartmouth College
Hanover, NH  03755
E-Mail: Nancy.P.Marion@Dartmouth.EDU
AB  - This paper analyzes the international reserve-holding behavior of developing countries. It shows that political-economy considerations modify the optimal reserve level determined by efficiency criteria. A country characterized by volatile output, inelastic demand for fiscal outlays, high tax collection costs and sovereign risk will want to accumulate international reserves as well as external debt. Efficiency considerations imply that reserves are optimal when the benefits they provide for intertemporal consumption and distortion smoothing equal the costs of acquiring them. However, a greater chance of opportunistic behavior by future policy makers reduces the demand for international reserves and increases external borrowing. Political corruption also reduces optimal reserve holdings. We provide some 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 behavior, a policy recommendation to increase international reserve holdings may be welfare-reducing.
ER  -