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Exchange Rate Policies at the Zero Lower Bound

Manuel Amador, Javier Bianchi (), Luigi Bocola () and Fabrizio Perri ()

No 740, Working Papers from Federal Reserve Bank of Minneapolis

Abstract: We study how a monetary authority pursues an exchange rate objective in an environment that features a zero lower bound (ZLB) constraint on nominal interest rates and limits to international arbitrage. If the nominal interest rate that is consistent with interest rate parity is positive, the central bank can achieve its exchange rate objective by choosing that interest rate, a well-known result in international ?nance. However, if the rate consistent with parity is negative, pursuing an exchange rate objective necessarily results in zero nominal interest rates, deviations from parity, capital in?ows, and welfare costs associated with the accumulation of foreign reserves by the central bank. In this latter case, all changes in external conditions that increase in?ows of capital toward the country are detrimental, while policies such as negative nominal interest rates or capital controls can reduce the costs associated with an exchange rate policy. We provide a simple way of measuring these costs, and present empirical support for the key implications of our framework: when interest rates are close to zero, violations in covered interest parity are more likely, and those violations are associated with reserve accumulation by central banks.

Keywords: Capital flows; CIP deviations; Currency pegs; Foreign exchange interventions; International reserves; Negative interest rates (search for similar items in EconPapers)
JEL-codes: F31 F32 F41 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2017-03-16
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mon and nep-opm
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Related works:
Journal Article: Exchange Rate Policies at the Zero Lower Bound (2020) Downloads
Working Paper: Exchange Rate Policies at the Zero Lower Bound (2017) Downloads
Working Paper: Exchange Rate Policies at the Zero Lower Bound (2017) Downloads
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