Essays on The Accumulation of International Reserves

Abstract

In the first chapter of this dissertation, I propose a novel theory of reserve accumulation that emphasizes the role of an independent central bank in an environment in which the government lacks fiscal discipline. Motivated by a positive correlation between central bank independence and the accumulation of international reserves in Latin America, I develop a quantitative sovereign default model with an independent central bank that can accumulate a risk-free foreign asset. I show that, if the central bank is more patient than the government and as patient as the households, in equilibrium, the government issues more debt than what is socially optimal and the central bank accumulates reserves to undo government over-borrowing. A key insight is that the government can issue more debt for any level of reserves but chooses not to because it would increase sovereign spreads, making it more costly to borrow. Quantitatively, I show that the central bank independence channel accounts for $83\%$ of the average level of reserves observed in Mexico from 1994 to 2017. I find that accumulating reserves by $7.2\%$ of the GDP reduces the net debt position by $3.3\%$ of GDP and increases social welfare by $0.1\%$. In the second chapter of this dissertation, I show that the existing literature cannot account for the level of reserves observed in most countries of East Asia and the Pacific Region. Therefore, I use a sovereign default model with reserve accumulation enhanced to incorporate learning-by-investing externalities to account for reserve levels that represent more than $25\%$ of GDP, as the observed levels in China, Cambodia, Thailand, and Malaysia. Even though this is a very preliminary work in progress, I show that, accumulating reserves reduces the availability of tradable goods relative to non-tradable goods, which implies a depreciation in the real exchange rate that contributes to boost economic growth. The next steps of this project include calibrate the model using data for China and use the model as a laboratory to quantify the welfare effects of financing public spending through the use of reserves rather than debt issuance or a tax reform. In the third chapter of this dissertation, Victor Almeida and I study the accumulation of international reserves in a two-period model of sovereign debt restructuring. We show that countries manage their reserves taking into account that these assets affect the outcomes of debt restructurings. In particular, countries may accumulate reserves while in default in order to improve their bargaining power in eventual debt restructurings.