Sustainable Exchange Rates

Luigi Bocola, Javier Bianchi, Fabrizio Perri and Manuel Amador
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Luigi Bocola: Northwestern University

No 1396, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: Central Banks of small integrated economies often have an exchange rate objective. We argue that achieving this objective is challenging when the Central Bank is also concerned about the size of its balance sheet. In addition, a world economy operating at the zero lower bound magnifies these difficulties. Specifically, in this paper we developed a framework where (i) the fear of future losses can rationalize why a Central Bank is worried about expanding the size of its balance sheet; (ii) this fear will impose limits on the exchange rate policies that a Central Bank will choose to implement; (iii) news about the future foreign interest rates can have significant effects on the domestic policy in a ZLB environment; (iv) commitment to future policies improves the Central Bank ability to sustain its exchange rate objectives.

Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1396

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