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Foreign exchange reserves in a credit constrained economy

Authors
Publisher
Birkbeck College, University of London
Publication Date
Keywords
  • Economics
  • Mathematics And Statistics

Abstract

We discuss the role of foreign exchange reserves as precautionary savings under an imperfect market framework due to the presence of endogenously determined borrowing constraints. We show that cost of holding reserves is higher in borrowing constrained economies than unconstrained ones as a result of the leverage effect of the debt. We also argue that high global reserve holdings can even be welfare reducing for the world economy where financially constrained developing countries are heavy borrowers in international lending markets.

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