The Theory of Reserve Accumulation, Revisited

Giancarlo Corsetti and Fred Seunghyun Maeng

No 2013_53, RSCAS Working Papers from European University Institute

Abstract: Discretionary governments may choose to default on their liabilities after issuing new debt, creatingintra-period uncertainty that may raise borrowing costs in a self-fulfilling manner. We show that, toeliminate this disruptive prospect, governments optimally build up reserves to ensure post-auctionrepayment in all circumstances. Intra-period risk naturally provides the foundations for a theory ofreserve accumulation. Optimal reserve policy shields the economy from disruptive (off-equilibrium)risk, substantially containing the costs and size of precautionary debt over-issuance. The modelexplains why governments hold large amounts of reserves and appear reluctant to use them facingfundamental shocks.

Keywords: Sovereign default; Foreign reserves; Self-fulfilling crises; Expectations; Discretionary Fiscal Policy; Debt sustainability (search for similar items in EconPapers)
Date: 2023-09
New Economics Papers: this item is included in nep-mon and nep-opm
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