Publications
Publications
- 2007
Optimal Reserve Management and Sovereign Debt
By: Laura Alfaro and Fabio Kanczuk
Abstract
Most models currently used to determine optimal foreign reserve holdings take the level of international debt as given. However, given the sovereign's willingness-to-pay incentive problems, reserve accumulation may reduce sustainable debt levels. In addition, assuming constant debt levels does not allow addressing one of the puzzles behind using reserves as a means to avoid the negative effects of crisis: why don't sovereign countries reduce their sovereign debt instead? To study the joint decision of holding sovereign debt and reserves, we construct a stochastic dynamic equilibrium model calibrated to a sample of emerging markets. We obtain that the reserve accumulation does not play a quantitative important role in this model. In fact, we find the optimal policy is not to hold reserves at all. This finding is robust to considering interest rate shocks, sudden stops, contingent reserves and reserve dependent output costs.
Keywords
Sovereign Finance; Borrowing and Debt; Financial Liquidity; International Finance; Emerging Markets; Mathematical Methods
Citation
Alfaro, Laura, and Fabio Kanczuk. "Optimal Reserve Management and Sovereign Debt." NBER Working Paper Series, No. 13216, July 2007.