Reserve Accumulation, Growth and Financial Crises

• Authors: Luca Fornaro.
• BSE Working Paper: 110752 | July 21
• Keywords: growth , financial crises , foreign reserve accumulation , gross capital flows , allocation , puzzle , exchange rate undervaluation
• JEL codes: F31, F32, F41, F43
• growth
• financial crises
• foreign reserve accumulation
• gross capital flows
• allocation
• puzzle
• exchange rate undervaluation

We present a model that reproduces two salient facts characterizing the international monetary system: Fast growing emerging countries i) run current account surpluses, ii) accumulate international reserves and receive net private in flows. 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 o set the government policy. The possibility of using reserves to provide liquidity during crises amplifies the positive impact of reserve accumulation on growth. 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.