The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
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.