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Reserve Accumulation, Foreign Direct Investment, and Economic Growth

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  • Hidehiko Matsumoto

    (University of Maryland)

Abstract

This paper develops a quantitative small-open-economy model to assess the optimal pace of foreign reserve accumulation by developing countries. The model features endogenous growth with foreign direct investment (FDI) entry and sudden stops of capital inflows to incorporate benefits of reserve accumulation. Reserve accumulation depreciates the real exchange rate and attracts FDI, which endogenously promotes productivity growth. When a sudden stop happens, the government uses accumulated reserves to prevent a severe economic downturn. The calibrated 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 debt, and the entry cost for FDI. The model suggests that these two factors can explain a substantial amount of the cross-country variation in the observed pace of reserve accumulation.

Suggested Citation

  • Hidehiko Matsumoto, 2018. "Reserve Accumulation, Foreign Direct Investment, and Economic Growth," 2018 Meeting Papers 237, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:237
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    Cited by:

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    2. Lutz, Flora & Zessner-Spitzenberg, Leopold, 2020. "Sudden Stops and Reserve Accumulation in the Presence of International Liquidity Risk," VfS Annual Conference 2020 (Virtual Conference): Gender Economics 224520, Verein für Socialpolitik / German Economic Association.
    3. Florencia S. Airaudo & Hernán D. Seoane, 2021. "The Trend-cycle Connection," Working Papers 97, Red Nacional de Investigadores en Economía (RedNIE).

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