International Reserve Holdings with Sovereign Risk and Costly Tax Collection

Joshua Aizenman and Nancy Marion ()

No 9154, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper analyzes the international reserve-holding behavior of developing countries. It shows that political-economy considerations modify the optimal reserve level determined by efficiency criteria. A country characterized by volatile output, inelastic demand for fiscal outlays, high tax collection costs and sovereign risk will want to accumulate international reserves as well as external debt. Efficiency considerations imply that reserves are optimal when the benefits they provide for intertemporal consumption and distortion smoothing equal the costs of acquiring them. However, a greater chance of opportunistic behavior by future policy makers reduces the demand for international reserves and increases external borrowing. Political corruption also reduces optimal reserve holdings. We provide some 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.

JEL-codes: F15 F32 (search for similar items in EconPapers)
Date: 2002-09
New Economics Papers: this item is included in nep-rmg
Note: IFM
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Citations: View citations in EconPapers (16)

Published as Aizenman, Joshua and Nancy Marion. "International Reserve Holdings With Sovereign Risk And Costly Tax Collection," Economic Journal, 2004, v114(497,Jul), 569-591.

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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 (2003)
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