Exchange Rate Policies at the Zero Lower Bound

65 Pages Posted: 27 Mar 2017

See all articles by Manuel Amador

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Luigi Bocola

Stanford University - Department of Economics; National Bureau of Economic Research (NBER)

Fabrizio Perri

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Multiple version iconThere are 2 versions of this paper

Date Written: March 2017

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 it exchange rate objective by choosing that interest rate, a well-known result in international finance. 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 inflows, 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 inflows 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

JEL Classification: F31, F32, F41

Suggested Citation

Amador, Manuel and Bianchi, Javier and Bocola, Luigi and Perri, Fabrizio, Exchange Rate Policies at the Zero Lower Bound (March 2017). CEPR Discussion Paper No. DP11928, Available at SSRN: https://ssrn.com/abstract=2941514

Manuel Amador (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Javier Bianchi

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Luigi Bocola

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
STANFORD, CA 94305-6072
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Fabrizio Perri

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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