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Foreign Reserve Accumulation, Foreign Direct Investment, and Economic Growth

Hidehiko Matsumoto ()

No 19-E-04, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: This paper develops a quantitative small-open-economy model to assess the optimal pace of foreign reserve accumulation by emerging and developing countries. In the model, reserve accumulation depreciates the real exchange rate and attracts foreign direct investment (FDI) inflows, which promotes productivity growth through endogenous firm dynamics. The economy is also subject to sudden stops in the form of an occasionally binding constraint on foreign borrowing, and accumulated reserves are used to prevent severe economic downturns. The model shows that two factors are the key determinants of the optimal pace of reserve accumulation: the elasticity of the foreign borrowing spread with respect to foreign debt, and the entry cost for FDI entry. The model suggests that these two factors can explain a substantial amount of the cross-country variation in the observed pace of reserve accumulation.

Keywords: Foreign Reserve Accumulation; Foreign Direct Investment; Sudden Stops; Endogenous Growth; Real Exchange Rate; Gross Capital Flows (search for similar items in EconPapers)
JEL-codes: F23 F31 F32 F41 F43 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-int and nep-opm
Date: 2019-03
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