Research

Abstract: 

How important are terms of trade shocks for the accumulation of reserves, and how do they differ from other income shocks? This paper quantifies the benefits of international reserves for emerging economies that face terms of trade shocks, particularly when their sovereign debt is denominated in foreign currency. We develop a dynamic model of endogenous sovereign default with reserve accumulation and exogenous fluctuations in terms of trade. Negative shocks raise debt service costs, but also increase the value of reserves, reducing the risk of default. Calibrated to Mexico, the model shows that terms of trade volatility is the main contributor to reserves accumulation. Absent reserves, default risk rises, consumption contracts more sharply, welfare declines, and consumption volatility increases—regardless of whether terms of trade are stochastic or deterministic. Our findings highlight the strategic role of reserves in mitigating external shocks and stabilizing macroeconomic outcomes.

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: 

2025: MEA (Kansas City); CEF (Santiago de Chile)

2024: SEA (Washington DC)

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

Abstract:

Dollarization is typically adopted by countries affected by large episodes of inflation and currency devaluation as a last resort tool. Dollarization is often seen to be costly for at least two reasons: the immediate cost associated with large devaluations, and the future costs related to the inability to freely adjust money supply and generate seigniorage. Hence, is dollarization an optimal policy? Who would choose it? In this paper we provide a theory for understanding whether dollarization can be an equilibrium optimal decision in a political economy framework. We construct an open-economy model with cash-in-advance constraints, dollar-denominated borrowing that can be adopted as legal tender, and two policymakers who alternate in power. We find that dollarization is optimally chosen by the more fiscally disciplined policymaker when the disagreement between the two types is larger, and when the less fiscally disciplined type remains in-office relatively more frequently.

Presentations: 

2025: MEA (Kansas City); CEF (Santiago de Chile)

2024: LACEA (Montevideo, Uruguay); SEA (Washington DC, USA) (*)

(*) Presented by co-authors

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.