Reserve Accumulation, Macroeconomic Stabilization, and Sovereign Risk
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.
For helpful comments, we thank Mark Aguiar, Yan Bai, Gideon Bornstein, Pierre-Olivier Gourinchas, Francesco Pappadà, Richard Rogerson, and seminar participants at Notre Dame, Princeton, Stony Brook, Universidad Nacional de Tucumán, Central Bank of Argentina, IMF Research Department, the 2018 SED Annual Meeting, the 2018 Annual UTDT Conference, the 2018 UNT Alumni Workshop, the ND-PUC Conference on Re-cent Advances in Macroeconomics, the 2019 Salento Macro Meetings, the 2019 NBER IFM Fall Meetings and the 2019 Annual Meeting of the SEU. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System, or the National Bureau of Economic Research.