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Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk

Flora Lutz and Leopold Zessner-Spitzenberg

VfS Annual Conference 2020 (Virtual Conference): Gender Economics from Verein für Socialpolitik / German Economic Association

Abstract: We propose a small open economy model where agents borrow internationally and invest in liquid foreign assets to insure against liquidity shocks, which temporarily shut out the economy of short-term credit markets. Due to the presence of a pecuniary externality individual agents borrow too much and hold too little liquid assets relative to a social planner. This inefficiency rationalizes macroprudential policy interventions in the form of reserve accumulation at the central bank coupled with a tax on foreign borrowing. Unless combined with other measures, a tax on foreign borrowing is detrimental to welfare; it reduces agents' incentives to invest in liquid assets and thereby increases financial instability. Our model can quantitatively match the simultaneous depreciation of the exchange rate and contractions in output, gross trade ows, foreign liabilities and foreign reserves during sudden stop episodes.

Keywords: international reserves; sudden stops; liquidity; macroprudential policy; pecuniary externalities (search for similar items in EconPapers)
JEL-codes: D62 E44 F32 F34 F41 (search for similar items in EconPapers)
Date: 2020
New Economics Papers: this item is included in nep-cba, nep-dge, nep-fdg, nep-ifn, nep-mac and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:vfsc20:224520

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