Paolo Cavallino
Published: 2017
Total Pages: 71
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Abstract I consider a small open economy model where international financial markets are imperfect and the exchange rate is determined by capital flows. I use this framework to study the effects of portfolio flow shocks, derive the optimal foreign exchange intervention policy, and characterize its interaction with monetary policy. I derive the optimal intervention rule in closed form as a function of three implicit targets. Finally, using Swiss data I provide evidence of the inefficiencies generated by capital flow shocks and quantify them by estimating the financial market friction that determines deviations from uncovered interest rate parity.