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Too much of a good thing? on the effects of limiting foreign reserve accumulation

Yan, Isabel K. and Kumhof, Michael (2011): Too much of a good thing? on the effects of limiting foreign reserve accumulation.

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Abstract

Some emerging economies have recently experienced large government surpluses and accelerating foreign exchange reserve accumulation far in excess of what would be implied by the literature on optimal reserves. China in particular has repeatedly stressed that there may be an upper limit to how many reserves it is willing to hold. Using a dynamic general equilibrium model, we show that the credible expectation of such a limit would lead to a balance of payments anti-crisis, which is characterized by an economic boom, real appreciation, growing demand for domestic currency, and domestic inflation, in the period prior to the limit being reached.

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