1. Leaning-against-the-wind intervention and the “carry-trade” view of the cost of reserves
- Author:
- Eduardo Levy-Yeyati and Juan Francisco Gómez
- Publication Date:
- 10-2022
- Content Type:
- Working Paper
- Institution:
- The John F. Kennedy School of Government at Harvard University
- Abstract:
- 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).
- Topic:
- Foreign Exchange, Economy, International Reserves, Trade, and Exchange Rates
- Political Geography:
- Global Focus