Foreign Exchange Intervention with UIP and CIP Deviations: The Case of Small Safe Haven Economies

Philippe Bacchetta, Kenza Benhima and Brendan Berthold
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Brendan Berthold: University of Lausanne

No 23-71, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We examine the welfare-based opportunity cost of foreign exchange (FX) intervention when both CIP and UIP deviations are present. We consider a small open economy that receives international capital flows through constrained international financial intermediaries. Deviations from CIP come from limited arbitrage or through a convenience yield, while UIP deviations are also affected by risk. We show that the sign of CIP and UIP deviations may differ for safe haven countries. We find that there may be a benefit, rather than a cost, of FX reserves if international intermediaries value the safe haven properties of a currency more than domestic households. We show that this has been the case for the Swiss franc and the Japanese Yen. We examine the optimal policy of a constrained central bank planner in this context.

Pages: 44 pages
Date: 2023-08
New Economics Papers: this item is included in nep-ban, nep-cba, nep-fdg, nep-ifn, nep-mon and nep-opm
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Citations: View citations in EconPapers (2)

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Working Paper: Foreign Exchange Intervention with UIP and CIP Deviations: The Case of Small Safe Haven Economies (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2371

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