Research

Abstract: 

How important are terms of trade shocks for reserves accumulation? What are the benefits of holding international reserves for emerging economies when they face terms of trade shocks and their sovereign debt is denominated in foreign currency? To quantify these benefits, we develop a model of endogenous sovereign default with international reserves accumulation and exogenous terms of trade. Negative terms of trade shocks increase debt service costs while simultaneously raising the value of international reserves holding, leading to lower default risk. Calibrated to Mexico for the period 1997-2019, we find that half of the reserves predicted by the model are explained by the terms of trade channel. Moreover, with no international reserves’ accumulation, default risk is higher, consumption falls more when the economy faced an adverse terms of trade shock, welfare is reduced, and the volatility of consumption raises regardless of whether the terms of trade are stochastic or deterministic.

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)