Dollar Shortages, CIP Deviations and the Safe Haven Role of the Dollar

RePEc Short ID: pda415
ORCID iD: 0000-0002-8522-8826

Bacchetta, Philippe; Davis, J. Scott; Van Wincoop, Eric

doi:10.24149/gwp425

Working Paper

Dollar Shortages, CIP Deviations and the Safe Haven Role of the Dollar

Abstract: Since 2007, an increase in risk or risk aversion has resulted in a U.S. dollar appreciation and greater deviations from covered interest parity (CIP). In contrast, prior to 2007, risk had no impact on the dollar, and CIP held. To explain these phenomena, we develop a two-country model featuring (i) market segmentation, (ii) limited CIP arbitrage (since 2007) and (iii) global dollar dominance. During periods of heightened global financial stress, dollar shortages in the offshore market emerge, leading to increased CIP deviations and a dollar appreciation. The appreciation occurs even in the absence of global dollar demand shocks. Central bank swap lines mitigate these effects.

Keywords: dollar; CIP deviations; Central Bank Swap Lines;

JEL Classification: E44; F31; G15;

https://doi.org/10.24149/gwp425