The portfolio balance channel of capital flows and foreign exchange intervention in a small open economy

Carlos Montoro; Marco Ortiz

doi:10.1016/j.jimonfin.2023.102825

The portfolio balance channel of capital flows and foreign exchange intervention in a small open economy

Carlos Montoro, Marco Ortiz

Producción científica: Contribución a una revista › Artículo de revista › revisión exhaustiva

2 Citas (Scopus)

Resumen

In this paper we extend a new Keynesian small open economy model with a segmented financial market featuring financial intermediaries as in Itskhoki and Mukhin (2021). The former ingredients generate deviations from the uncovered interest parity (UIP) condition. More precisely, the portfolio decisions of financial intermediaries add a time varying risk-premium element to the traditional UIP that depends on foreign exchange intervention (FXI) and FX orders by foreign investors. We present closed form solutions for optimal FXI. Additionally, we analyse the effectiveness of different FXI rules commonly discussed across policymakers. Our findings are as follows: (i) FXI rules can improve welfare in presence of the portfolio balance channel; (ii) under a general parametrization, fundamental shocks can trigger an inefficient path for the exchange rate; (iii) optimal policy calls for leaning against the wind to portfolio flow shocks and leaning with the wind to fundamental shocks; (iv) the effectiveness of FXI rules depends on the frequency and nature of the shocks and parameters characterizing the economy.

Idioma original	Inglés
Número de artículo	102825
Publicación	Journal of International Money and Finance
Volumen	133
DOI	https://doi.org/10.1016/j.jimonfin.2023.102825
Estado	Publicada - may. 2023

Nota bibliográfica

Funding Information:
☆ An earlier version of this paper circulated under the title “Foreign Exchange Intervention and Monetary Policy Design: a Market Microstructure Analysis”. We are grateful to Lawrence Christiano, Paolo Vitale, Wouter J. Den Haan, Muhammad Ali Nasir, Paul Castillo, Fernando Perez, Freddy Pinzón and Ken Miyahara as well as the participants of the BIS 4th CCA conference, the Northwestern University, Federal Reserve of Atlanta, Bank of Canada and BCRP seminar, the 3rd Financial Economics Meeting, LACEA-LAMES 2022 and the 2022 CEMLA-FRBNY-ECB conference. We also thank the Editor-in-Chief, the Guest Editor and the referees for suggesting substantial improvements. We are grateful to Gerardo Herrera for his excellent research assistance. This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.

Publisher Copyright:
© 2023 Elsevier Ltd

ODS de las Naciones Unidas

Este resultado contribuye a los siguientes Objetivos de Desarrollo Sostenible

Acceder al documento

10.1016/j.jimonfin.2023.102825

Otros archivos y enlaces

2 Citas de Scopus
1 Documento de trabajo

The portfolio channel of capital flows and foreign exchange intervention in a small open economy
Montoro, C. & Ortiz, M., ago. 2020, Lima, 42 p. (Working paper; n.º 168).
Producción científica: Documento de trabajo

Acceso abierto

Citar esto

@article{276c8de569ab4be29a31f9b8d104e072,

title = "The portfolio balance channel of capital flows and foreign exchange intervention in a small open economy",

abstract = "In this paper we extend a new Keynesian small open economy model with a segmented financial market featuring financial intermediaries as in Itskhoki and Mukhin (2021). The former ingredients generate deviations from the uncovered interest parity (UIP) condition. More precisely, the portfolio decisions of financial intermediaries add a time varying risk-premium element to the traditional UIP that depends on foreign exchange intervention (FXI) and FX orders by foreign investors. We present closed form solutions for optimal FXI. Additionally, we analyse the effectiveness of different FXI rules commonly discussed across policymakers. Our findings are as follows: (i) FXI rules can improve welfare in presence of the portfolio balance channel; (ii) under a general parametrization, fundamental shocks can trigger an inefficient path for the exchange rate; (iii) optimal policy calls for leaning against the wind to portfolio flow shocks and leaning with the wind to fundamental shocks; (iv) the effectiveness of FXI rules depends on the frequency and nature of the shocks and parameters characterizing the economy.",

keywords = "Exchange rates, Foreign exchange intervention, Monetary policy",

author = "Carlos Montoro and Marco Ortiz",

note = "Publisher Copyright: {\textcopyright} 2023 Elsevier Ltd",

year = "2023",

month = may,

doi = "10.1016/j.jimonfin.2023.102825",

language = "English",

volume = "133",

}

TY - JOUR

T1 - The portfolio balance channel of capital flows and foreign exchange intervention in a small open economy

AU - Montoro, Carlos

AU - Ortiz, Marco

PY - 2023/5

Y1 - 2023/5

N2 - In this paper we extend a new Keynesian small open economy model with a segmented financial market featuring financial intermediaries as in Itskhoki and Mukhin (2021). The former ingredients generate deviations from the uncovered interest parity (UIP) condition. More precisely, the portfolio decisions of financial intermediaries add a time varying risk-premium element to the traditional UIP that depends on foreign exchange intervention (FXI) and FX orders by foreign investors. We present closed form solutions for optimal FXI. Additionally, we analyse the effectiveness of different FXI rules commonly discussed across policymakers. Our findings are as follows: (i) FXI rules can improve welfare in presence of the portfolio balance channel; (ii) under a general parametrization, fundamental shocks can trigger an inefficient path for the exchange rate; (iii) optimal policy calls for leaning against the wind to portfolio flow shocks and leaning with the wind to fundamental shocks; (iv) the effectiveness of FXI rules depends on the frequency and nature of the shocks and parameters characterizing the economy.

AB - In this paper we extend a new Keynesian small open economy model with a segmented financial market featuring financial intermediaries as in Itskhoki and Mukhin (2021). The former ingredients generate deviations from the uncovered interest parity (UIP) condition. More precisely, the portfolio decisions of financial intermediaries add a time varying risk-premium element to the traditional UIP that depends on foreign exchange intervention (FXI) and FX orders by foreign investors. We present closed form solutions for optimal FXI. Additionally, we analyse the effectiveness of different FXI rules commonly discussed across policymakers. Our findings are as follows: (i) FXI rules can improve welfare in presence of the portfolio balance channel; (ii) under a general parametrization, fundamental shocks can trigger an inefficient path for the exchange rate; (iii) optimal policy calls for leaning against the wind to portfolio flow shocks and leaning with the wind to fundamental shocks; (iv) the effectiveness of FXI rules depends on the frequency and nature of the shocks and parameters characterizing the economy.

KW - Exchange rates

KW - Foreign exchange intervention

KW - Monetary policy

UR - http://www.scopus.com/inward/record.url?scp=85150809107&partnerID=8YFLogxK

UR - https://www.mendeley.com/catalogue/4f32ebd6-6897-3b77-a05b-912a1e74e08a/

U2 - 10.1016/j.jimonfin.2023.102825

DO - 10.1016/j.jimonfin.2023.102825

M3 - Article in a journal

AN - SCOPUS:85150809107

SN - 0261-5606

VL - 133

JO - Journal of International Money and Finance

JF - Journal of International Money and Finance

M1 - 102825

ER -

The portfolio balance channel of capital flows and foreign exchange intervention in a small open economy

Resumen

Nota bibliográfica

ODS de las Naciones Unidas

Acceder al documento

Otros archivos y enlaces

Huella

Producción científica

The portfolio channel of capital flows and foreign exchange intervention in a small open economy

Citar esto