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Sudden stops and reserve accumulation in the presence of international liquidity risk

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  • Lutz, Flora
  • Zessner-Spitzenberg, Leopold

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 a pecuniary externality, individual agents overborrow and hold too little liquid assets relative to a social planner. This inefficiency rationalizes macroprudential policy intervention in the form of reserve accumulation at the central bank to stabilize trade and the real exchange rate. Our model quantitatively matches the depreciation of the real exchange rate and contractions in output, gross trade flows, and foreign reserve holdings during Sudden Stops.

Suggested Citation

  • Lutz, Flora & Zessner-Spitzenberg, Leopold, 2023. "Sudden stops and reserve accumulation in the presence of international liquidity risk," Journal of International Economics, Elsevier, vol. 141(C).
    • Handle: RePEc:eee:inecon:v:141:y:2023:i:c:s0022199623000156
    DOI: 10.1016/j.jinteco.2023.103729
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    3. Corsetti, G. & Maeng, S. H., 2023. "The Theory of Reserve Accumulation, Revisited," Janeway Institute Working Papers 2319, Faculty of Economics, University of Cambridge.
    4. Corsetti, G. & Maeng, S. H., 2023. "The Theory of Reserve Accumulation, Revisited," Cambridge Working Papers in Economics 2370, Faculty of Economics, University of Cambridge.

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    More about this item

    Keywords

    International reserves; Sudden stops; Liquidity; Macroprudential policy; Pecuniary externalities;
    All these keywords.

    JEL classification:

    • D62 - Microeconomics - - Welfare Economics - - - Externalities
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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