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A GROWTH PERSPECTIVE ON FOREIGN RESERVE ACCUMULATION

Published online by Cambridge University Press:  10 March 2014

Gong Cheng
Gong Cheng*
Affiliation:
Sciences Po and European Stability Mechanism
*
Address correspondence to: Gong Cheng, Department of Economics, Sciences Po, 28, rue des Saints-Pères, 75007 Paris, France; e-mail: gong.cheng@sciencespo.fr.
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Abstract

Based on a dynamic open-economy macroeconomic model, this paper analyzes the motive for foreign reserve accumulation in fast-growing emerging economies. The demand for foreign reserves stems from the interaction between productivity growth and underdevelopment of the domestic financial market. As domestic firms are credit-constrained, domestic saving instruments are necessary to increase their retained earnings in order to invest in capital. The central bank plays the role of a financial intermediary and provides liquid public bonds while investing the bond proceeds abroad in the form of foreign reserves. Foreign reserve accumulation is thus part of a catching-up strategy in an economy facing financial frictions. During economic transition, foreign reserve accumulation is proved to be welfare-improving as long as private capital flows are controlled. This joint strategy enables the central bank to channel sufficient external funding to the domestic economy while keeping domestic interest rates under control to cope with positive productivity shocks.

Keywords

Foreign ReservesCapital ControlsFinancial FrictionsCapital FormationProductivity Growth
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Special Issue 6: Growth, Optimal Fiscal and Monetary Policy, and Financial Frictions , September 2015 , pp. 1358 - 1379
Copyright
Copyright © Cambridge University Press 2014 

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