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The Underlying Link between Fiscal Policy Patterns and International Reserves
Author(s) -
Zhou Yan
Publication year - 2010
Publication title -
review of development economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.531
H-Index - 50
eISSN - 1467-9361
pISSN - 1363-6669
DOI - 10.1111/j.1467-9361.2010.00583.x
Subject(s) - economics , fiscal policy , monetary economics , incentive , shock (circulatory) , macroeconomics , foreign exchange reserves , exchange rate , international economics , market economy , medicine
This paper extends the model in Aizenman and Marion (2004) to study the underlying link and interaction between fiscal policy patterns and international reserves in developing countries. It shows that because of conditional access to international credit markets, the immediate impact of an adverse shock on an emerging economy is a lower level of international reserves and a procyclical fiscal policy. However, facing the uncertainty of future shocks, the authorities in this economy then have a strong incentive to hoard more precautionary reserves if possible. If the economy successfully accumulates more reserves, it can have a lower tax rate in the second period and its fiscal policy would be more countercyclical. The model's predictions are consistent with new empirical findings.