The Theory of Reserve Accumulation, Revisited

Giancarlo Corsetti and Fred Seunghyun Maeng

No 18644, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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: Sovereign default; Foreign reserves; Self-fulfilling crises; Expectations; Debt sustainability (search for similar items in EconPapers)
JEL-codes: E43 E62 F34 H50 H63 (search for similar items in EconPapers)
Date: 2023-11
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