The Theory of Reserve Accumulation, Revisited

Giancarlo Corsetti and Seung Hyun Maeng

Janeway Institute Working Papers from Faculty of Economics, University of Cambridge

Abstract: Uncertainty about a government willingness to repay its outstanding liabilities upon auctioning new debt creates vulnerability to belief-driven hikes in borrowing costs. We show that optimizing policymakers will eliminate such vulnerability by accumulating reserves up to ensuring post-auction debt repayment in all (off-equilibrium) circumstances. The model helps explaining why governments hold significant amounts of reserves and appear reluctant to use them to smooth fundamental shocks. Quantitatively, the model explains reserve holdings up to 3% of GDP if debt is short term, 2.4% with long-term debt—as long bond maturities mitigate vulnerability to belief-driven crises.

Keywords: Debt Sustainability; Discretionary Fiscal Policy; Expectations; Foreign Reserves; Self-Fulfilling Crises; Sovereign Default (search for similar items in EconPapers)
JEL-codes: E43 E62 F34 H50 H63 (search for similar items in EconPapers)
Date: 2023-11-08
New Economics Papers: this item is included in nep-dge, nep-mon and nep-opm
Note: gc422, sm2215
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Persistent link: https://EconPapers.repec.org/RePEc:cam:camjip:2319

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