Exchange Rate Policies at the Zero Lower Bound

Manuel Amador, Javier Bianchi, Luigi Bocola, Fabrizio Perri

NBER Working Paper No. 23266
Issued in March 2017, Revised in September 2017
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

Recently, several economies with interest rates close to zero have received large capital inflows while their central banks accumulated large foreign reserves. Concurrently, significant deviations from covered interest parity have appeared. We show that, with limited international arbitrage, a central bank’s pursuit of an exchange rate policy at the ZLB can explain these facts. We provide a measure of the costs associated with this policy and show they can be sizable. Changes in external conditions that increase capital inflows are detrimental, even when they are beneficial away from the ZLB. Negative nominal rates and capital controls can reduce the costs.

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Document Object Identifier (DOI): 10.3386/w23266

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