Undervaluation through Foreign Reserve Accumulation : Static Losses, Dynamic Gains

This paper shows that real exchange rate undervaluation through the accumulation of foreign reserves may improve welfare in economies with learning-by-investing externalities that arise disproportionately from the tradable sector. In the presence of targeting problems or when policy choices are restricted by multilateral agreements, first-best policies such as subsidies to capital accumulation, or subsidies to tradable production are not feasible. A neo-mercantilist policy of foreign reserve accumulation "outsources" the targeting problem or overcomes the multilateral restrictions by providing loans to foreigners that can only be used to buy up domestic tradable goods. This raises the relative price of tradable versus non-tradable goods (i.e. undervalues the real exchange rate) at the static cost of temporarily reducing tradable absorption in the domestic economy. However, since the tradable sector generates greater learning-by-investing externalities, it leads to dynamic gains in the form of higher growth. The net welfare effects of reserve accumulation depend on the balance between the static losses from lower tradable absorption versus the dynamic gains from higher growth.

Bibliographic Details

Main Authors:	Korinek, Anton, Servén, Luis
Language:	English
Published:	Washington, DC: World Bank 2010-03-01
Subjects:	ABSOLUTE VALUE, ACCUMULATION OF CAPITAL, ADVERSE SHOCKS, AGENCY PROBLEM, AGENCY PROBLEMS, AGGREGATE CAPITAL STOCK, ALLOCATION OF CAPITAL, AMOUNT OF CAPITAL, BENCHMARK, BUDGET CONSTRAINT, CAPITAL ACCOUNT, CAPITAL ACCOUNT OPENNESS, CAPITAL ACCOUNT RESTRICTIONS, CAPITAL ACCOUNTS, CAPITAL ACCUMULATION, CAPITAL ALLOCATION, CAPITAL FLIGHT, CAPITAL FLOWS, CAPITAL FORMATION, CAPITAL INCOME, CAPITAL INFLOW, CAPITAL INFLOWS, CAPITAL INVESTMENT, CAPITAL MARKET, CAPITAL MARKETS, CAPITAL OUTFLOW, CAPITAL OWNERS, CAPITAL SHARE, CAPITAL SHARES, CAPITAL STOCK, CLOSED CAPITAL ACCOUNTS, CLOSED ECONOMY, COMPARATIVE ADVANTAGE, CONSUMERS, CONSUMPTION GROWTH, COST OF INVESTMENT, CRRA, CURRENCY, CURRENT ACCOUNT, CURRENT ACCOUNT BALANCE, CURRENT ACCOUNT DEFICITS, CURRENT ACCOUNT SURPLUS, DEPRECIATION, DEPRECIATION RATE, DEVALUATION, DEVELOPING COUNTRIES, DEVELOPMENT ECONOMICS, DIFFERENTIAL TAXATION, DISCOUNTED VALUE, DISTORTION, DISTORTIONS, DOMESTIC CAPITAL, DOMESTIC CONSUMPTION, DOMESTIC CURRENCY, DOMESTIC ECONOMY, DOMESTIC INTEREST RATE, DOMESTIC INTEREST RATES, DOMESTIC PRICE, DUTCH DISEASE, ECONOMIC DEVELOPMENT, ECONOMIC GROWTH, ECONOMIC IMPLICATIONS, ELASTICITY, ELASTICITY OF SUBSTITUTION, EMERGING ECONOMIES, EMERGING MARKET, EMERGING MARKET COUNTRIES, EQUILIBRIA, EQUILIBRIUM, EQUILIBRIUM CONDITION, EQUILIBRIUM CONDITIONS, EXCHANGE RATE DEVALUATION, EXPENDITURE, EXPENDITURES, EXPORT SUBSIDIES, EXPORT SUBSIDY, EXTERNALITIES, EXTERNALITY, FACTOR MARKETS, FAIR TRADE, FINANCIAL ASSETS, FINANCIAL SUPPORT, FISCAL POLICY, FOREIGN DIRECT INVESTMENT, FOREIGN INTEREST, FOREIGN INTEREST RATES, FOREIGN INVESTMENT, FOREIGN RESERVE, FOREIGN RESERVES, FRAUD, FREE TRADE, GDP, GENERAL EQUILIBRIUM, GENERAL EQUILIBRIUM MODELS, GLOBAL ECONOMY, GOVERNMENT EXPENDITURE, GOVERNMENT FINANCES, GOVERNMENT INTERVENTION, GOVERNMENT INVESTMENT, GOVERNMENT POLICIES, GOVERNMENT POLICY, GOVERNMENT REVENUE, GOVERNMENT SPENDING, GROWTH MODELS, GROWTH RATE, GROWTH RATES, HOLDING, HOLDINGS, HUMAN CAPITAL, IMPORT, IMPORT TARIFF, IMPORT TARIFFS, IMPORTS, INCOME, INCOME EFFECT, INCREASING RETURNS, INCREASING RETURNS TO SCALE, INDIFFERENCE CURVES, INFANT INDUSTRY ARGUMENT, INFLATION, INSTITUTIONAL CAPACITIES, INSTITUTIONAL CAPACITY, INSTRUMENT, INSURANCE, INTANGIBLE, INTEREST INCOME, INTEREST RATE, INTEREST RATES, INTERNATIONAL BANK, INTERNATIONAL ECONOMICS, INTERNATIONAL INTEREST, INTERNATIONAL INTEREST RATE, INTERNATIONAL PRICE, INTERNATIONAL TRADE, INVESTING, INVESTMENT EXPENDITURES, INVESTMENT OPPORTUNITIES, INVESTMENT RATE, LABOR MARKET, LDCS, LEVEL OF INVESTMENT, LEVIES, MACROECONOMICS, MARGINAL PRODUCT, MARGINAL PRODUCTIVITY, MARKET CONDITION, MARKET EQUILIBRIUM, MARKET INTEREST RATE, MARKET POWER, MARKET PRICE, MARKET PRICES, MERCANTILISM, MONEY HOLDINGS, MULTILATERAL TRADE, NATURAL RESOURCE, NATURAL RESOURCES, NEGATIVE EXTERNALITIES, NET EXPORTS, NOMINAL EXCHANGE RATE, OPEN ECONOMY, OPTIMAL ALLOCATION, OPTIMIZATION, ORGANIZATIONAL CAPITAL, POLICY RESPONSES, POLITICAL ECONOMY, PREVAILING MARKET PRICES, PRIVATE CAPITAL, PRIVATE CAPITAL STOCK, PRIVATE INVESTMENT, PRIVATE INVESTMENTS, PRODUCTION FUNCTION, PRODUCTION FUNCTIONS, PRODUCTIVE INVESTMENT, PRODUCTIVITY, PRODUCTIVITY GROWTH, PROFIT MAXIMIZATION, PUBLIC GOOD, PUBLIC INVESTMENT, PUBLIC ¯ SPENDING, RATE OF RETURN, RATES OF RETURN, REAL COST, REAL EXCHANGE RATE, RELATIVE PRICE, RELATIVE WEIGHTS, RESERVE, RESERVE ACCUMULATION, RESERVES, RETURN, SAVINGS RATE, SAVINGS RATES, SEIGNIORAGE, SLOW GROWTH, SPECULATIVE CAPITAL INFLOWS, STEADY STATE, SUBSTITUTION EFFECT, SUPPLY OF CREDIT, TAX, TAX CREDIT, TAX POLICY, TAX RATE, TAX RATES, TAXATION, TOTAL OUTPUT, TRADABLE GOOD, TRADABLE GOODS, TRADE AGREEMENTS, TRADE DEFICIT, TRADE POLICY, UNDERVALUATION, UTILITY FUNCTION, WAGES, WORLD ECONOMY, WORLD INTEREST RATE, WORLD MARKET, WTO,
Online Access:	http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20100325103944 https://hdl.handle.net/10986/3737
Tags:	Add Tag No Tags, Be the first to tag this record!