Working Paper | HBS Working Paper Series | 2014

Debt Redemption, Reserve Accumulation, and Exchange-Rate Regimes

by Laura Alfaro and Fabio Kanczuk

Abstract

Foreign participation in local-currency-bond markets in emerging countries has increased dramatically over the past decade. In light of this trend, we revisit the question of the optimal exchange-rate regime when developing countries can borrow internationally with local-currency-denominated debt. We find that, as local-currency-bond markets develop, a "pseudo-flexible regime," whereby a country accumulates reserves in conjunction with debt, is the policy that most effectively stabilizes fluctuations under real external shocks.

Keywords: foreign reserves; local-currency bonds; carry trade; exchange-rate regimes; International Finance; Currency Exchange Rate; Financial Markets; Developing Countries and Economies;

Citation:

Alfaro, Laura, and Fabio Kanczuk. "Debt Redemption, Reserve Accumulation, and Exchange-Rate Regimes." Harvard Business School Working Paper, No. 13-074, February 2013. (Revised July 2014. NBER Working Paper Series, No. 19098, June 2013)