Optimal Reserve Management at the Zero Lower Bound

Luigi Bocola, Javier Bianchi, Fabrizio Perri and Manuel Amador
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Javier Bianchi: Federal Reserve Bank of Minneapolis

No 1269, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: Consider a Central Bank whose target exchange rate policy is in conflict, under perfect capital mobility, with the zero lower bound constraint on the domestic interest rate. With limited capital mobility, such a Central Bank can achieve its exchange rate policy by intervening in foreign exchange markets and accumulating foreign assets. This paper is concerned with the optimal composition of the accumulated foreign wealth. For a relatively open economy, a sufficient and necessary condition for an optimal policy is that foreign investors remain indifferent between holding local currency and any other domestic asset. For a relatively closed economy, on the other hand, a Central Bank should invest in assets that pay when the domestic currency appreciates. The covered interest parity deviation provides a lower bound to the arbitrage losses generated per unit of foreign capital inflow. Restrictions on the ability of foreign capital to leverage domestically may raise welfare.

Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:1269

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