Working paper

An Integrated Approach to Government Financial Policy (WP 99/08)


In this paper, I address three questions of government financial policy: how should a government's aversion to financial risk be determined, when are new financial investments justified, and what is the optimal level of reserves in a flexible exchange rate regime. To answer these questions, I modify an integrated financial model developed by Froot and Stein (1998) to describe private sector financial policy. Financial risk aversion in this model is due to the potential of poor financial returns limiting an institution's future investment opportunities. The potential for poor returns provides governments with incentives to hold reserves and limit new financial investments.