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Gradual Portfolio Adjustment, Foreign Exchange Intervention, and Open Market Operations

Author

Listed:
  • Rong Li

    (School of Finance, Renmin University of China)

  • Dongzhou Mei

    (School of International Economics and Trade, Central University of Finance and Economics)

  • Bing Tong

    (Center for Financial Development and Stability at Henan University, and School of Economics at Henan University, Kaifeng, Henan)

Abstract

We introduce gradual adjustment costs for both domestic and foreign bonds in a New Keynesian small open economy model, unifying the theories of foreign exchange intervention and the liquidity effect. With gradual adjustment for foreign bonds, interest rate differentials lead to persistent capital flows. With adjustment costs for domestic bonds, open market operations generate a stronger liquidity effect, which has real effects in an environment with costly intermediation. Furthermore, under gradual portfolio adjustment, nominal interest rates change temporarily in response to asset transactions, so that the model can restore equilibrium when the steady-state asset ratios have changed.

Suggested Citation

  • Rong Li & Dongzhou Mei & Bing Tong, 2024. "Gradual Portfolio Adjustment, Foreign Exchange Intervention, and Open Market Operations," CFDS Discussion Paper Series 2024/6, Center for Financial Development and Stability at Henan University, Kaifeng, Henan, China.
    • Handle: RePEc:fds:dpaper:202406
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    File URL: http://cfds.henuecon.education/images/dpaper/WP_6_2024_portfolio-adjustment.pdf
    File Function: First version, 2024
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    More about this item

    Keywords

    Gradual portfolio adjustment; Foreign Exchange intervention; Open market operations; Capital flows; Liquidity effect; Small open economy; New Keynesian model;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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