Optimally Controlled Long-Term Stability : Bond Financed Reserves in a Small Open Economy

This paper is concerned with international reserves where the accumulation of reserves is financed by public debt. Optimally controlled paths are used to illustrate the possibility of long term instability in a small macroeconomic system. The results indicate that reserve accumulation financed by public debt can lead to a potential debt crisis because it may destabilize the economic system in the longer term. In the most serious case, weak fundamentals combined with bond financed reserve accumulation may lead to multiple liquidity crises