International Reserve Holdings with Sovereign Risk and Costly Tax Collection

Joshua Aizenman and Nancy Marion ()

Santa Cruz Department of Economics, Working Paper Series from Department of Economics, UC Santa Cruz

Abstract: We derive a precautionary demand for international reserves in the presence of sovereign risk and show that political-economy considerations modify the optimal level of reserve holdings. A greater chance of opportunistic behavior by future policy makers and political corruption reduce the demand for international reserves and increase external borrowing. We provide evidence to support these findings. Consequently, the debt-to-reserves ratio may be less useful as a vulnerability indicator. A version of the Lucas Critique suggests that if a high debt-to-reserves ratio is a symptom of opportunistic behavior, a policy recommendation to increase international reserve holdings may be welfare-reducing.

Keywords: intertemporal consumption and distortion smoothing; political instability; corruption (search for similar items in EconPapers)
Date: 2003-11-01
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Citations: View citations in EconPapers (9)

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Journal Article: International Reserve Holdings with Sovereign Risk and Costly Tax Collection (2004)
Working Paper: International Reserve Holdings with Sovereign Risk and Costly Tax Collection (2003)
Working Paper: International Reserve Holdings with Sovereign Risk and Costly Tax Collection (2002)
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