Korinek, AntonServén, Luis2012-03-192012-03-192010-03-01https://hdl.handle.net/10986/3737This paper shows that real exchange rate undervaluation through the accumulation of foreign reserves may improve welfare in economies with learning-by-investing externalities that arise disproportionately from the tradable sector. In the presence of targeting problems or when policy choices are restricted by multilateral agreements, first-best policies such as subsidies to capital accumulation, or subsidies to tradable production are not feasible. A neo-mercantilist policy of foreign reserve accumulation "outsources" the targeting problem or overcomes the multilateral restrictions by providing loans to foreigners that can only be used to buy up domestic tradable goods. This raises the relative price of tradable versus non-tradable goods (i.e. undervalues the real exchange rate) at the static cost of temporarily reducing tradable absorption in the domestic economy. However, since the tradable sector generates greater learning-by-investing externalities, it leads to dynamic gains in the form of higher growth. The net welfare effects of reserve accumulation depend on the balance between the static losses from lower tradable absorption versus the dynamic gains from higher growth.CC BY 3.0 IGOABSOLUTE VALUEACCUMULATION OF CAPITALADVERSE SHOCKSAGENCY PROBLEMAGENCY PROBLEMSAGGREGATE CAPITAL STOCKALLOCATION OF CAPITALAMOUNT OF CAPITALBENCHMARKBUDGET CONSTRAINTCAPITAL ACCOUNTCAPITAL ACCOUNT OPENNESSCAPITAL ACCOUNT RESTRICTIONSCAPITAL ACCOUNTSCAPITAL ACCUMULATIONCAPITAL ALLOCATIONCAPITAL FLIGHTCAPITAL FLOWSCAPITAL FORMATIONCAPITAL INCOMECAPITAL INFLOWCAPITAL INFLOWSCAPITAL INVESTMENTCAPITAL MARKETCAPITAL MARKETSCAPITAL OUTFLOWCAPITAL OWNERSCAPITAL SHARECAPITAL SHARESCAPITAL STOCKCLOSED CAPITAL ACCOUNTSCLOSED ECONOMYCOMPARATIVE ADVANTAGECONSUMERSCONSUMPTION GROWTHCOST OF INVESTMENTCRRACURRENCYCURRENT ACCOUNTCURRENT ACCOUNT BALANCECURRENT ACCOUNT DEFICITSCURRENT ACCOUNT SURPLUSDEPRECIATIONDEPRECIATION RATEDEVALUATIONDEVELOPING COUNTRIESDEVELOPMENT ECONOMICSDIFFERENTIAL TAXATIONDISCOUNTED VALUEDISTORTIONDISTORTIONSDOMESTIC CAPITALDOMESTIC CONSUMPTIONDOMESTIC CURRENCYDOMESTIC ECONOMYDOMESTIC INTEREST RATEDOMESTIC INTEREST RATESDOMESTIC PRICEDUTCH DISEASEECONOMIC DEVELOPMENTECONOMIC GROWTHECONOMIC IMPLICATIONSELASTICITYELASTICITY OF SUBSTITUTIONEMERGING ECONOMIESEMERGING MARKETEMERGING MARKET COUNTRIESEQUILIBRIAEQUILIBRIUMEQUILIBRIUM CONDITIONEQUILIBRIUM CONDITIONSEXCHANGE RATE DEVALUATIONEXPENDITUREEXPENDITURESEXPORT SUBSIDIESEXPORT SUBSIDYEXTERNALITIESEXTERNALITYFACTOR MARKETSFAIR TRADEFINANCIAL ASSETSFINANCIAL SUPPORTFISCAL POLICYFOREIGN DIRECT INVESTMENTFOREIGN INTERESTFOREIGN INTEREST RATESFOREIGN INVESTMENTFOREIGN RESERVEFOREIGN RESERVESFRAUDFREE TRADEGDPGENERAL EQUILIBRIUMGENERAL EQUILIBRIUM MODELSGLOBAL ECONOMYGOVERNMENT EXPENDITUREGOVERNMENT FINANCESGOVERNMENT INTERVENTIONGOVERNMENT INVESTMENTGOVERNMENT POLICIESGOVERNMENT POLICYGOVERNMENT REVENUEGOVERNMENT SPENDINGGROWTH MODELSGROWTH RATEGROWTH RATESHOLDINGHOLDINGSHUMAN CAPITALIMPORTIMPORT TARIFFIMPORT TARIFFSIMPORTSINCOMEINCOME EFFECTINCREASING RETURNSINCREASING RETURNS TO SCALEINDIFFERENCE CURVESINFANT INDUSTRY ARGUMENTINFLATIONINSTITUTIONAL CAPACITIESINSTITUTIONAL CAPACITYINSTRUMENTINSURANCEINTANGIBLEINTEREST INCOMEINTEREST RATEINTEREST RATESINTERNATIONAL BANKINTERNATIONAL ECONOMICSINTERNATIONAL INTERESTINTERNATIONAL INTEREST RATEINTERNATIONAL PRICEINTERNATIONAL TRADEINVESTINGINVESTMENT EXPENDITURESINVESTMENT OPPORTUNITIESINVESTMENT RATELABOR MARKETLDCSLEVEL OF INVESTMENTLEVIESMACROECONOMICSMARGINAL PRODUCTMARGINAL PRODUCTIVITYMARKET CONDITIONMARKET EQUILIBRIUMMARKET INTEREST RATEMARKET POWERMARKET PRICEMARKET PRICESMERCANTILISMMONEY HOLDINGSMULTILATERAL TRADENATURAL RESOURCENATURAL RESOURCESNEGATIVE EXTERNALITIESNET EXPORTSNOMINAL EXCHANGE RATEOPEN ECONOMYOPTIMAL ALLOCATIONOPTIMIZATIONORGANIZATIONAL CAPITALPOLICY RESPONSESPOLITICAL ECONOMYPREVAILING MARKET PRICESPRIVATE CAPITALPRIVATE CAPITAL STOCKPRIVATE INVESTMENTPRIVATE INVESTMENTSPRODUCTION FUNCTIONPRODUCTION FUNCTIONSPRODUCTIVE INVESTMENTPRODUCTIVITYPRODUCTIVITY GROWTHPROFIT MAXIMIZATIONPUBLIC GOODPUBLIC INVESTMENTPUBLIC ¯ SPENDINGRATE OF RETURNRATES OF RETURNREAL COSTREAL EXCHANGE RATERELATIVE PRICERELATIVE WEIGHTSRESERVERESERVE ACCUMULATIONRESERVESRETURNSAVINGS RATESAVINGS RATESSEIGNIORAGESLOW GROWTHSPECULATIVE CAPITAL INFLOWSSTEADY STATESUBSTITUTION EFFECTSUPPLY OF CREDITTAXTAX CREDITTAX POLICYTAX RATETAX RATESTAXATIONTOTAL OUTPUTTRADABLE GOODTRADABLE GOODSTRADE AGREEMENTSTRADE DEFICITTRADE POLICYUNDERVALUATIONUTILITY FUNCTIONWAGESWORLD ECONOMYWORLD INTEREST RATEWORLD MARKETWTOWorld Bank10.1596/1813-9450-5250