Liquidity Management under Fixed Exchange Rate with Open Capital Account

Mariam El Hamiani Khatat and Romain Veyrune

No 2019/058, IMF Working Papers from International Monetary Fund

Abstract: This paper introduces a theoretical framework for liquidity management under fixed exchange rate arrangement, derived from the price-specie flow mechanism of David Hume. The framework highlights that the risk of short-term money market rates un-anchoring from the uncovered interest rate parity due to money and foreign exchange market frictions could jeopardize financial stability and market development. The paper then discusses operational solutions that stabilize money market rates close to the level implied by the Uncovered Interest Rate Parity (UIP). Liquidity management under fixed exchange rate with an open capital account presents specific challenges due to: (1) the larger liquidity shocks induced by foreign reserve swings that challenge the development of money markets; and (2) more complicated liquidity forecasts. The theoretical framework is empirically tested based on the estimate of “offset” coefficients for Denmark and Hong Kong SAR.

Keywords: WP; exchange rate; central bank; interest rate; rate; Fixed exchange rate regime; price-specie flow mechanism; uncovered interest rate parity; offset coefficients; monetary operations; autonomous factors; money and foreign exchange markets; discount window; capital account; supply curve; money market rate; excess reserves; FX intervention; central bank liquidity management; liquidity absorption operation; liquidity-providing operation; liquidity shock; money demand; country risk; Conventional peg; Exchange rate arrangements; Money markets; Liquidity management; Global (search for similar items in EconPapers)
Pages: 57
Date: 2019-03-18
New Economics Papers: this item is included in nep-mac and nep-mon
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Citations: View citations in EconPapers (1)

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