Leaning-Against-the-Wind Intervention and the “Carry-Trade” View of the Cost of Reserves

For a sample of emerging economies, we estimate the quasi-fiscal costs of sterilized foreign exchange interventions as the P&L of an inverse carry trade. We show that these costs can be substantial when intervention has a neo-mercantilist motive (preserving an undervalued currency) or a stabiliz...

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Bibliographic Details
Published in:Open economies review 2022-11, Vol.33 (5), p.853-877
Main Authors: Levy-Yeyati, Eduardo, Gómez, Juan Francisco
Format: Article
Language:English
Subjects:
Central banks
Costs
Credit risk
Development Economics
Economic Policy
Economics
Economics and Finance
Emerging markets
European Integration
Foreign exchange
Foreign exchange markets
Foreign exchange rates
Interest rates
International Economics
International finance
Intervention
Macroeconomics/Monetary Economics//Financial Economics
Research Article
Reserve assets
Sovereign debt
Stabilization
Volatility
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Summary:For a sample of emerging economies, we estimate the quasi-fiscal costs of sterilized foreign exchange interventions as the P&L of an inverse carry trade. We show that these costs can be substantial when intervention has a neo-mercantilist motive (preserving an undervalued currency) or a stabilization motive (appreciating the exchange rate as a nominal anchor) but are rather small when interventions follow a countercyclical, leaning-against-the-wind (LAW) pattern to contain exchange rate volatility. We document that under LAW, central banks outperform a constant size carry trade, as they additionally benefit from buying against cyclical deviations, and that the cost of reserves under the carry-trade view is generally lower than the one obtained from the credit-risk view (which equals the marginal cost to the country´s sovereign spread).
ISSN:0923-7992
1573-708X
DOI:10.1007/s11079-022-09689-z