FX Intervention in the New Keynesian Model

Author/Editor:

Zineddine Alla ; Raphael A Espinoza ; Atish R. Ghosh

Publication Date:

September 29, 2017

Electronic Access:

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Summary:

We develop an open economy New Keynesian Model with foreign exchange intervention in the presence of a financial accelerator mechanism. We obtain closed-form solutions for the optimal interest rate policy and FX intervention under discretionary policy, in the face of shocks to risk appetite in international capital markets. The solution shows that FX intervention can help reduce the volatility of the economy and mitigate the welfare losses associated with such shocks. We also show that, when the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high. We determine the conditions under which indeterminacy can occur and highlight how the use of FX intervention reinforces the central bank’s credibility and limits the risk of multiple equilibria.

Series:

Working Paper No. 17/207

Subject:

English

Publication Date:

September 29, 2017

ISBN/ISSN:

9781484320617/1018-5941

Stock No:

WPIEA2017207

Price:

$18.00 (Academic Rate:$18.00)

Format:

Paper

Pages:

39

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