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 an inflation decline in emerging economies. In this paper we study how central bank independence in these countries accounts for the trends observed in the data by constructing a sovereign default model with two authorities, a fiscal and a monetary authority, in which debt is issued to foreign investors and denominated in local currency. Having an independent central bank allows to accumulate more international reserves and sustain higher levels of external debt at lower default risk than in a consolidated authority model. This leads to two opposing effects on inflation: on the one hand, higher reserves increases consumption lowering its marginal utility and reducing inflation; on the other, higher levels of debt increases the incentives to generate inflation for dilution purposes. The direction and the magnitude of effects depend on the calibration of the model.

Presentations: 

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

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.