A Fiscal Theory of the Currency Risk Premium and of Sterilized Intervention

Author/Editor:

Michael Kumhof ; Stijn van Nieuwerburgh

Publication Date:

February 1, 2002

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

This paper develops a dynamic stochastic general equilibrium monetary portfolio choice model that accomplishes two objectives. First, it provides a theory of currency risk premia based on a weak and plausible form of fiscal nonneutrality. Domestic and foreign bonds become imperfect substitutes, the uncovered interest parity condition is replaced with a portfolio balance equation, and the central bank can separately choose the growth rate of its nominal anchor and the domestic bond interest rate. Second, it can turn be shown that, and how, sterilized intervention affects equilibrium allocations and prices.

Series:

Working Paper No. 02/29

Subject:

English

Publication Date:

February 1, 2002

ISBN/ISSN:

9781451844818/1018-5941

Stock No:

WPIEA0292002

Format:

Paper

Pages:

44

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