Essays on international reserves in developing countries

My dissertation studies the association between international reserves and fiscal policy in developing countries. It identifies a relationship between the cyclical pattern of fiscal policy and international reserves accumulation in developing countries and analyzes how this relationship is associated with political risk and conditional access to global capital markets.; Chapter one investigates empirically how fiscal policy pattern may affect international reserves accumulation in developing countries. It finds that for developing countries with low political risk and limited access to global capital markets, countries conducting counter-cyclical fiscal policies hold more reserves while countries conducting pro-cyclical fiscal policies hold fewer reserves. For developing countries with high political risk, the link between international reserves and fiscal policy pattern is not clear-cut. The paper also investigates how the relationship may be affected by government domestic borrowing. It finds that during bad times, if government domestic borrowing as a percentage of GDP is low, the impact of fiscal policy on international reserves is still significant. But if government domestic borrowing is high, the impact is no longer significant.; Chapter two extends the empirical study in chapter one by building a simultaneous equations model to accommodate the possible dual causality between fiscal policy pattern and international reserve. It finds evidence in support of the relationship between the cyclical pattern of fiscal policy and international reserves accumulation. Specifically, it finds that higher international reserves relative to GDP indeed put the government in a better position to conduct stabilizing fiscal policy. And during bad times, a counter-cyclical (pro-cyclical) fiscal policy is associated with higher (lower) international reserve holding. But this association is more clear-cut and stronger in countries with low political distortions or high reliance on external borrowing.; Chapter three provides the theoretical justification for the empirical findings in the previous two chapters by extending the model in Aizenman and Marion (2004). It introduces fiscal policy pattern into the model by looking at the response of net tax rate to productivity shocks in the first period. It finds that a counter-cyclical (pro-cyclical) fiscal policy is indeed associated with higher (lower) optimal international reserve holdings if political distortions are absent. When political distortions are introduced, this relationship is no longer clear-cut during good times.