International Reserves and Central Bank Independence
This paper proposes a novel theory of reserve accumulation that emphasizes the role of an independent central bank. Motivated by a positive correlation between reserve accumulation and central bank independence in Latin America, the paper develops...
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| Format: | Working Paper |
| Language: | English |
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World Bank, Washington, DC
2021
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| Online Access: | http://documents.worldbank.org/curated/undefined/620131635859663291/International-Reserves-and-Central-Bank-Independence http://hdl.handle.net/10986/36483 |
| Summary: | This paper proposes a novel theory of
reserve accumulation that emphasizes the role of an
independent central bank. Motivated by a positive
correlation between reserve accumulation and central bank
independence in Latin America, the paper develops a
quantitative sovereign default model with an independent
central bank that can accumulate a risk-free foreign asset.
The findings show that if the central bank is more patient
than the government and as patient as households are, in
equilibrium, the government issues more debt than what is
socially optimal, and the central bank accumulates reserves
to undo government over-borrowing. A key insight is that the
government can issue more debt for any level of reserves but
chooses not to because doing so would increase sovereign
spreads, making it more costly to borrow. Quantitatively,
the analysis finds that the central bank independence
channel accounts for 75 percent of the average reserve
levels observed in Mexico from 1994 to 2017. Finally, the
paper shows that accumulating reserves improves social
welfare. Welfare gains come from reducing the costs of
front-loading public spending. |
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