Foreign Exchange Reserves in a Credit Constrained Economy

Kurmaş Akdoğan

No 1014, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: We discuss the role of foreign exchange reserves as precautionary savings under an imperfect market framework due to the presence of endogenously determined borrowing constraints. We show that cost of holding reserves is higher in borrowing constrained economies than unconstrained ones as a result of the leverage effect of the debt. We also argue that high global reserve holdings can even be welfare reducing for the world economy where financially constrained developing countries are heavy borrowers in international lending markets.

Date: 2010-09
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https://eprints.bbk.ac.uk/id/eprint/7528 First version, 2010 (application/pdf)

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