International Reserves, Credit Constraints, and Systemic Sudden Stops

Abstract

Why do emerging market economies simultaneously hold very high levels of international reserves and foreign liabilities? Moreover, why, even with such huge amounts of international reserves, did countries barely use them during the Global Financial Crisis? I argue that including international reserves as an implicit collateral for external borrowing in a small open economy model subject to exogenous financial shocks can explain both of these puzzling facts. I find that the model can obtain ratios of international reserves and net foreign liabilities to GDP similar to those of Latin American countries. Additionally, the optimal policy implies that the government accumulates international reserves before a sudden stop and that there is a small depletion during it. Finally, an alternative policy of keeping international reserves constant at the average level yields results very similar to those of the optimal policy during sudden stops, highlighting the stabilizing role of international reserves even if central banks do not use them. JEL classification: F32, F34, F41Key words: international reserves, emerging market economies, sudden stops, international crises * This paper is based on the second chapter of my dissertation at Columbia University. I am grateful to Martin Uribe, Stephanie Schmitt-Grohe, and Jose Alexandre Scheinkman for constant guidance and support. I would also like to thank, for very useful comments and suggestions, Saki Bigio,

Sudden stops and reserve accumulation in the presence of international liquidity risk

“…Most closely related to this paper are recent contributions which jointly study reserve accumulation and emerging market crises in quantitative frameworks, in particular Arce, Bengui, and Bianchi (2019), Bianchi, Hatchondo, and Martinez (2018) and Shousha (2017). Arce, Bengui, and Bianchi (2019) show that foreign reserve accumulation can be used to implement the constrained efficient allocation in the model of Bianchi (2011), if reserves carry the same interest as foreign borrowing.…”

“…See e.g Obstfeld, Shambaugh, and Taylor (2010). andCalvo, Izquierdo, and Loo-Kung (2013).2 Exceptions includeBianchi, Hatchondo, and Martinez (2018),Arce, Bengui, and Bianchi (2019) andShousha (2017). We discuss our relation to these studies below.3 This type of borrowing constraint has been widely studied sinceMendoza (2002).…”