Why do so Many Oil Exporters Peg Their Currency? Foreign Reserves as a De-facto Sovereign Wealth Fund

Abstract

In developing countries, committing to a stable real exchange rate during a resource boom allows the central bank to build a de-facto sovereign wealth fund if the government fails to do so. Governments should optimally save resource revenues in a sovereign wealth fund, though this often fails due to corruption, political expediency or fear of raiding. If private agents have limited access to international capital markets, then the central bank controls net saving in the economy. During the boom the central bank will stabilize the real exchange rate below the equilibrium level by accumulating foreign reserves, which can support permanently higher consumption. Doing so replaces a sharp, temporary appreciation with a modest, permanent one; improves welfare relative to no intervention or an open capital account; and prevents raiding which would involve abandoning a very visible peg. This may explain why seventy-five per cent of resource-dependent economies peg their currency, despite the obvious short-run advantages of floating exchange rates for stabilizing commodity shocks.

Citation

Wills, S.; van der Ploeg, R. Why do so Many Oil Exporters Peg Their Currency? Foreign Reserves as a De-facto Sovereign Wealth Fund. Presented at Joint RES-SPR Conference on “Macroeconomic Challenges FacingLow-Income Countries,” Washington, DC, January 30–31, 2014. International Monetary Fund, Washington DC, USA (2014) 22 pp.

Why do so Many Oil Exporters Peg Their Currency? Foreign Reserves as a De-facto Sovereign Wealth Fund

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