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Foreign Exchange Intervention with UIP and CIP Deviations: The Case of Small Safe Haven Economies

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  • Bacchetta, Philippe
  • Benhima, Kenza
  • Berthold, Brendan

Abstract

We examine the welfare-based opportunity cost of foreign exchange (FX) intervention when both CIP and UIP deviations are present. We consider a small open economy that receives international capital flows through constrained international financial intermediaries. Deviations from CIP come from limited arbitrage or through a convenience yield, while UIP deviations are also affected by risk. We show that the sign of CIP and UIP deviations may differ for safe haven countries. We find that there may be a benefit, rather than a cost, of FX reserves if international intermediaries value the safe haven properties of a currency more than domestic households. We show that this has been the case for the Swiss franc and the Japanese Yen. We examine the optimal policy of a constrained central bank planner in this context.

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  • Bacchetta, Philippe & Benhima, Kenza & Berthold, Brendan, 2023. "Foreign Exchange Intervention with UIP and CIP Deviations: The Case of Small Safe Haven Economies," CEPR Discussion Papers 18469, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18469
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    Cited by:

    1. Graziano, Marco & Habib, Maurizio Michael, 2024. "Mutual funds and safe government bonds: do returns matter?," Working Paper Series 2931, European Central Bank.
    2. Cosimo Petracchi, 2024. "The Macro Neutrality of Exchange-Rate Regimes in the presence of Exporter-Importer Firms," CEIS Research Paper 580, Tor Vergata University, CEIS, revised 15 Jul 2024.

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