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Low-income countries routinely experience exogenous disturbances—sharp swings in the terms of trade, export demand, natural disasters, and volatile financial flows—that contribute to higher volatility in aggregate output and consumption compared with other countries. Assessing Reserve Adequacy in Low-Income Countries presents the findings of an analysis of a range of external shocks faced by these countries, beginning with a discussion of the impact of external shocks on macroeconomic growth, volatility, and welfare. Although sound macroeconomic and prudential policy frameworks are the first line of defense for limiting vulnerability, international reserves constitute the main form of self-insurance against such shocks. The evidence suggests that low-income countries with reserve coverage above three months of imports were better able to smooth consumption and absorption in the face of external shocks compared with those with lower reserve holdings. The analysis also points to the importance of country characteristics and vulnerabilities in assessing reserve adequacy.

Foreign exchange reserves --- Finance --- Business & Economics --- International Finance --- Currency reserves, Foreign --- Foreign currency reserves --- Foreign reserves (Foreign exchange reserves) --- International reserves (Foreign exchange reserves) --- Reserves, Foreign exchange --- Finance, Public --- Reserves (Accounting) --- E-books --- Banks and Banking --- Exports and Imports --- Financial Risk Management --- Foreign Exchange --- Macroeconomics --- Trade: General --- Empirical Studies of Trade --- Macroeconomics: Consumption --- Saving --- Wealth --- Monetary Policy --- Currency --- Foreign exchange --- International economics --- Banking --- Exchange rate arrangements --- Imports --- Exchange rate flexibility --- Consumption --- Conventional peg --- Reserve positions --- Central banks --- Reserves accumulation --- National accounts --- Economics --- Fiscal policy --- Economic policy --- nternational cooperation --- United States

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Two striking facts about international capital flows in emerging economies motivate this paper: (1) Governments hold large amounts of international reserves, for which they obtain a return lower than their borrowing cost. (2) Purchases of domestic assets by nonresidents and purchases of foreign assets by residents are both procyclical and collapse during crises. We propose a dynamic model of endogenous default that can account for these facts. The government faces a trade-off between the benefits of keeping reserves as a buffer against rollover risk and the cost of having larger gross debt positions. Long-duration bonds, the countercyclical default premium, and sudden stops are important for the quantitative success of the model.

Capital movements --- Default (Finance) --- Risk --- Economics --- Uncertainty --- Probabilities --- Profit --- Risk-return relationships --- Finance --- Finance, Public --- Repudiation --- Capital flight --- Capital flows --- Capital inflow --- Capital outflow --- Flight of capital --- Flow of capital --- Movements of capital --- Balance of payments --- Foreign exchange --- International finance --- Econometric models. --- Foreign exchange reserves --- Currency reserves, Foreign --- Foreign currency reserves --- Foreign reserves (Foreign exchange reserves) --- International reserves (Foreign exchange reserves) --- Reserves, Foreign exchange --- Reserves (Accounting) --- E-books --- Banks and Banking --- Exports and Imports --- Financial Risk Management --- Investments: Bonds --- Macroeconomics --- Current Account Adjustment --- Short-term Capital Movements --- International Lending and Debt Problems --- Open Economy Macroeconomics --- International Investment --- Long-term Capital Movements --- Personal Income, Wealth, and Their Distributions --- Monetary Policy --- Debt --- Debt Management --- Sovereign Debt --- General Financial Markets: General (includes Measurement and Data) --- International economics --- Banking --- Investment & securities --- Sudden stops --- Personal income --- Reserves accumulation --- Debt refinancing --- Bonds --- Central banks --- National accounts --- Asset and liability management --- Financial institutions --- Income --- Mexico