Research

Abstract: 

What are the benefits of holding international reserves under terms of trade shocks when sovereign debt is denominated in foreign currency? To answer this question, we develop a model of endogenous sovereign default with international reserves accumulation. A negative terms of trade shock increases the service cost of debt but, at the same time, it raises the value of international reserves holding which may help reducing default risk. Calibrated to 16 emerging economies over the period period 1997-2019 we find that, in a model with no reserves accumulation, default risk is twice as high relative to the benchmark calibration and consumption falls 50% more when the economy is hit by a terms of trade shock. Not holding reserves increases the volatility of consumption by 17% with respect to the benchmark, 40% more than a model with no terms of trade variability.

Presentations: 

2023: Universidad de Chile FEN; Reed College, Inter-American Development Bank; Board of Governors; Banco de Mexico; Washington College; CEBRA Workshop for Commodities and Macroeconomics, Washington DC

2022: MEA Meeting, EGSC WUSTL,  SEA Meeting (accepted); 

Abstract:

Over the last decades, we have observed a rise in international reserve accumulation and disinflation in emerging economies. In this paper we study how central bank independence in these countries accounts for these facts by constructing a sovereign default model with two authorities, a fiscal and a monetary authority, in which debt is issued to foreign investors and is denominated in local currency. Having an independent central bank allows one to accumulate more international reserves which reduces the need for external debt issuance and lowers default risk relative to a consolidated authority model. We calibrate the model to Mexico and find that a more independent central bank, a more patient one, accumulates more international reserves and is associated with lower debt and inflation rates. 

Presentations: 

2023: LACEA, Bogota; Seminar at Central Bank of Costa Rica

2024: SEA, Washington DC (Scheduled)

Abstract:

Dollarization is typically adopted by countries affected by large episodes of inflation and currency devaluation as a last resort tool. However, dollarization is often seen to be costly for at least two main reasons: first, the (potential) immediate cost associated with large devaluations, and second, the future costs related to the inability to freely adjust money supply and generate seigniorage flows for the public authority. Considering these costs, is dollarization an optimal strategy? In this paper, we provide a framework for understanding whether dollarization can be rationalized as an equilibrium optimal decision. We construct an open economy model with (domestic) money and international reserves, which can be adopted as legal tender; given the state of the economy, the public authority has the option to dollarize or maintain the domestic currency. We then compare the dollarization option with other institutional designs to assess the (eventual) existence of welfare-improving monetary arrangements.

Presentations: 

2024: LACEA, Montevideo (Scheduled)

Abstract:

During the 2011-2012 European debt crisis, banks in peripheral countries increased their domestic sovereign bonds exposure, jeopardizing their ability to lend to firms. This paper aims at studying how the deterioration of domestic banks' balance sheets, due to higher sovereign risk, increases home bias in local government bonds, reduces lending to the domestic private sector, and affects the real economy. We build an open economy dynamic stochastic model in which banks in the home country can trade both domestic and foreign sovereign debt. We find that an exogenous spike in sovereign spreads can lead to higher levels of home bias, lower private lending and lower domestic output.