Exchange Rate Policies at the Zero Lower Bound. (27th November 2019)

• Record Type: Journal Article
• Authors: Amador, Manuel; Bianchi, Javier; Bocola, Luigi; Perri, Fabrizio
• Is Part Of: Review of economic studies. Volume 87:Number 4(2020)
• Page Start: 1605
• Page End: 1645
• Publication Date: 2019-11-27
• Subjects: Capital flows -- CIP deviations -- Currency pegs -- Foreign exchange interventions -- International reserves; F31 -- F32 -- F41; Economics -- Periodicals; 330
• DOI: 10.1093/restud/rdz059
• Languages: English
• ISSNs: 0034-6527

Abstract

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.