Foreign Exchange Intervention under Policy Uncertainty

By Gustavo Adler, Ruy Lama, Juan Pablo Medina Guzman

March 17, 2016

Preview Citation

Format: Chicago

Gustavo Adler, Ruy Lama, and Juan Pablo Medina Guzman. Foreign Exchange Intervention under Policy Uncertainty, (USA: International Monetary Fund, 2016) accessed September 20, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We study the use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions. Under full information, a central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty, where agents perceive that monetary policy may also have exchange rate stabilization goals, the use of FX intervention entails a trade-off, reducing output volatility while increasing inflation volatility. While having an additional policy tool is always beneficial, we find that the optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These results indicate that the benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.

Subject: Banking, Capital inflows, Exchange rates, Foreign exchange, Inflation

Keywords: Monetary policy, WP

Publication Details

Pages:

40
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2016/067
Stock No:

WPIEA2016067
ISBN:

9781475520415
ISSN:

1018-5941

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