Working Paper 740

Exchange Rate Policies at the Zero Lower Bound

Manuel Amador | Monetary Advisor
Javier Bianchi | Senior Research Economist
Luigi Bocola | Research Economist
Fabrizio Perri | Monetary Advisor

Revised October 2, 2017

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.

Download Paper (pdf)