Excess Reserves and Macroeconomic Instability

This paper is concerned with international reserves. It makes two main points. Firstly, excess reserves cannot be regarded as a substitute for sound fundamentals because the former may destabilize the economic system in the longer term. Secondly, reserve accumulation financed by public debt can lead to a potential debt crisis in developing countries. Optimal control theory is employed to illustrate the stabilization problem in an economy in which excess reserves are financed by fiscal deficit