Liquidity Management under Fixed Exchange Rate with Open Capital Account

By Mariam El Hamiani Khatat, Romain M Veyrune

March 18, 2019

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Format: Chicago

Mariam El Hamiani Khatat, and Romain M Veyrune. Liquidity Management under Fixed Exchange Rate with Open Capital Account, (USA: International Monetary Fund, 2019) accessed November 12, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

This paper introduces a theoretical framework for liquidity management under fixed exchange rate arrangement, derived from the price-specie flow mechanism of David Hume. The framework highlights that the risk of short-term money market rates un-anchoring from the uncovered interest rate parity due to money and foreign exchange market frictions could jeopardize financial stability and market development. The paper then discusses operational solutions that stabilize money market rates close to the level implied by the Uncovered Interest Rate Parity (UIP). Liquidity management under fixed exchange rate with an open capital account presents specific challenges due to: (1) the larger liquidity shocks induced by foreign reserve swings that challenge the development of money markets; and (2) more complicated liquidity forecasts. The theoretical framework is empirically tested based on the estimate of “offset” coefficients for Denmark and Hong Kong SAR.

Subject: Asset and liability management, Banking, Conventional peg, Exchange rate arrangements, Financial markets, Foreign exchange, Liquidity management, Money markets

Keywords: Autonomous factors, Capital account, Central bank, Central bank liquidity management, Conventional peg, Country risk, Discount window, Excess reserves, Exchange rate, Exchange rate arrangements, Fixed exchange rate regime, FX intervention, Global, Interest rate, Liquidity absorption operation, Liquidity management, Liquidity shock, Liquidity-providing operation, Monetary operations, Money and foreign exchange markets, Money demand, Money market rate, Money markets, Offset coefficients, Price-specie flow mechanism, Rate, Supply curve, Uncovered interest rate parity, WP

Publication Details

Pages:

57
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2019/058
Stock No:

WPIEA2019058
ISBN:

9781498302913
ISSN:

1018-5941

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