Working Paper: NBER ID: w23266
Authors: Manuel Amador; Javier Bianchi; Luigi Bocola; Fabrizio Perri
Abstract: We study the problem of a monetary authority pursuing an exchange rate policy that is inconsistent with interest rate parity because of a binding zero lower bound constraint. The resulting violation in interest rate parity generates an inflow of capital that the monetary authority needs to absorb by accumulating foreign reserves. We show that these interventions by the monetary authority are costly, and we derive a simple measure of these costs: they are proportional to deviations from the covered interest parity (CIP) condition and the amount of accumulated foreign reserves. Our framework can account for the recent experiences of “safe-haven” currencies and the sign of their observed deviations from CIP.
Keywords: exchange rate policy; zero lower bound; interest rate parity; capital inflows; foreign reserves
JEL Codes: F31; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Exchange rate policy (F31) | capital inflows (F21) |
| capital inflows (F21) | accumulation of foreign reserves (F31) |
| Exchange rate policy (F31) | resource costs incurred by monetary authority (E50) |
| capital inflows (F21) | resource costs incurred by monetary authority (E50) |
| CIP deviations (L15) | resource costs incurred by monetary authority (E50) |