DP13952 A Macroprudential Theory of Foreign Reserve Accumulation

Author(s): Fernando Arce, Julien Bengui, Javier Bianchi
Publication Date: August 2019
Date Revised: September 2019
Keyword(s): financial crises, International Reserves, macroprudential policy
JEL(s): D52, D62, F24, F38
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13952

This paper proposes a theory of foreign reserves as macroprudential policy. We study an open economy model of financial crises, in which pecuniary externalities lead to overborrowing, and show that by accumulating international reserves, the government can achieve the constrained-efficient allocation. The optimal reserve accumulation policy leans against the wind and significantly reduces the exposure to financial crises. The theory is consistent with the joint dynamics of private and official capital flows, both over time and in the cross section, and can quantitatively account for the recent upward trend in international reserves.