Research

“Bank Runs, Sovereign Risk, and International Reserves”, Job Market Paper

Abstract: Policymakers in developing countries often argue that an important reason for having international reserves is to have adequate liquidity in the event of shocks like bank runs. This paper studies the effect of domestic bank run risks on government reserve accumulation in a quantitative model of systemic bank runs and sovereign default with short-term debt and a risk-free asset. When countries’ fundamentals are weak, pessimistic expectations of investors can lead to runs on the domestic banking system. A government which commits to aggressively intervene ex-post can help to eliminate the “pessimistic” run equilibrium. Such intervention, by simply borrowing in the face of an impending crisis, is costly because interest rates rise sharply in crisis times. One way to prepare for crises is to build up a stock of international reserves in normal times. A quantitative exercise finds welfare gains of procyclical reserve accumulation policies to be economically substantial, suggesting that precautionary savings in light of domestic financial instability risks is an important channel through which reserve accumulation helps stabilize the economy and improves welfare.

“Optimal Foreign Exchange Intervention”, 2018.

Abstract: Foreign exchange interventions are frequently used by central banks around the world to influence the exchange rate or to increase reserve buffers for precautionary reasons. This paper proposes a mechanism in which sterilized foreign exchange interventions, by changing the composition of the relative stocks of domestic and foreign assets held by the public, have real effects on aggregate variables. We explore this non-neutrality property using a small open economy model with domestic banks subject to borrowing constraints on foreign credit and domestic assets with different collateralizing properties. A sterilized purchase of foreign reserves increases the supply of government bonds held by private agents. On one hand, this intervention crowds out private investment as private agents can no longer borrow freely from abroad to offset government borrowing when the borrowing constraint binds. On the other hand, due to its attractive collateralizing quality, government bond has the benefit of relaxing the borrowing constraint especially when foreign credit is large. Thus, the total supply of government bond affects private credit flows, causing real effects on the exchange rate and aggregate variables. The analysis yields several important implications for optimal foreign exchange intervention policy.

"Financial Intermediaries and Capital Misallocation", with Mohammad Khani