## Foreign Exchange Intervention Through the Lens of the Quantitative Integrated Policy Framework: The Case of Albania

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**Canonical URL:** [Foreign Exchange Intervention Through the Lens of the Quantitative Integrated Policy Framework: The Case of Albania](https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025038.pdf)

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### Introduction and Context
- IMF’s integrated policy framework (IPF) identifies three frictions that may warrant foreign exchange intervention (FXI): (i) shallow or temporarily illiquid FX markets; (ii) unhedged currency exposures of balance sheets; and (iii) de-anchoring of inflation expectations from high exchange rate pass-through.
- Albania: small open emerging market with inflation targeting; sustained appreciation of the lek amid a tourism boom.
- Bank of Albania (BoA) FX intervention: size of FXI during the first 9 months of 2024 amounted to 2.6 percent of 2023 nominal GDP, almost triple the amount of the same period in 2023.
- FX markets characterized as shallow: yearly turnover of 11 billion USD versus average turnover among emerging market economies of 52 billion USD.
- Sample and document timing: model estimated on quarterly series for Albania over 2009–2024; paper completed on December 17, 2024.

### Key Findings
- Shallow FX markets are the primary IPF friction in Albania that may create a case for FXI.
- The appreciation of the lek has been primarily driven by fundamental factors; conventional interest rate policy is generally the appropriate tool for such fundamental shocks.
- FXI can be an effective complementary tool in certain circumstances where fundamental appreciation is compounded by non-fundamental shocks (e.g., shifts in foreign investor risk appetite), helping to alleviate output-inflation tradeoffs.
- FX mismatches and de-anchored inflation expectations appear broadly contained:
  - Share of unhedged FX loans declined from 50 percent of total loans in 2014 to 25 percent in 2024.
  - Residual risks concentrated in real estate (accounts for two-thirds of unhedged FX loans in 2024).
  - Empirical exchange rate passthrough to headline CPI shows a cumulative impact of about 0.2 percent (for a 1-percent appreciation) over four quarters.
- Inflation expectations are estimated to be well-anchored in the medium and long run.

### QIPF / QIPF Model (Estimated for Albania)
- Model characteristics:
  - New Keynesian open-economy QIPF model tailored to AEs and EMEs; home economy “small” relative to euro area.
  - Extended to include trend productivity growth and a domestic financial sector.
  - Assumes FX intermediaries have limited risk-bearing capacity (as in Gabaix and Maggiori, 2015), which generates realistic exchange rate volatility and implies sterilized FX interventions have real effects.
- Estimation details:
  - Estimated using Bayesian maximum likelihood on a dozen quarterly series for 2009–2024.
  - Euro area block estimated separately; euro area variables included to account for foreign influences.
- Model properties:
  - Nominal exchange rate pass-through to consumer prices is gradual due to local currency pricing-to-market behavior.
  - Interest rate policy gradually adjusts to deviations of expected one-year ahead core inflation from target and activity (output gap) and transmits effectively to prices and the exchange rate relative to output.
  - Preferred specification indicates FX market shallowness: sterilized FX interventions that persistently affect the lek can have sizeable macroeconomic effects on core inflation and activity, particularly if the domestic policy rate is passive.

### Scenario Analysis — Tourism Boom
- Stylized scenario: tourism-driven expansion with higher net exports, stronger domestic demand, appreciation of the real exchange rate; shocks phased in gradually (MIT shocks).
- Central bank realism: policy maker does not have perfect foresight and gradually learns about the evolving increase in potential output.
- Baseline (historic) monetary policy:
  - Monetary policy follows estimated historical policy rule; eases because lek appreciation and productivity improvements reduce inflationary pressures.
  - Potential output rises faster than actual output, causing inflation to fall below target.
- Alternative (discretionary) monetary action:
  - Additional policy rate cuts assumed to offset lek appreciation (for illustration).
  - Result: output gap narrows and inflation moves closer to target while avoiding volatile interest rate movements.
  - Quantified improvement: alternative policy delivers a 25 percent improvement (measured by a standard central bank objective function quadratic in output gap and inflation) over the historical policy response in the scenario.
- Conclusion for tourism (fundamental) shocks:
  - Monetary policy is an appropriate tool; FXI is not necessary for fundamental shocks despite shallow markets.
  - The challenge is recognizing in real time that potential output has risen.

### Risk Shocks, Non-Fundamental Flows, and Policy Trade-offs
- Model allows capital flows driven by non-fundamental (“risk-on”) shocks that impact the real exchange rate through market shallowness.
- Long-run variance decomposition of consumption-based RER:
  - Fundamental shocks are the principal driver.
  - Non-fundamental shocks contributed around 5 percent to long-run RER variance if FXI is reacting to exchange rate movements.
  - Non-fundamental shocks contributed around 15 percent to long-run RER variance assuming no FX interventions are used to lean against exchange rate movements.
- Shorter horizons: risk shocks can have more material effects; since 2021 risk shocks appear to have appreciated the lek by around 11 percent (cumulative contribution in the model’s counterfactual).
- Policy trade-off:
  - Exchange rate volatility driven by non-fundamental factors can create trade-offs between stabilizing output and stabilizing inflation.
  - In such episodes, FXI can be useful to lean against temporary, sentiment-driven capital in- and outflows, complementing conventional monetary and macroprudential tools.

### Policy Implications and Recommendations
- Primary policy tool for fundamental appreciation (e.g., tourism-driven) should be conventional interest rate policy, given its traction on prices and the exchange rate.
- FXI can be justified as a complementary tool when:
  - FX markets are shallow, and
  - Non-fundamental, sentiment-driven capital flows cause outsized and potentially destabilizing exchange rate movements over short horizons.
- Macroprudential measures (MPMs) and targeted microprudential actions are preferable to FXI for addressing remaining FX mismatch risks concentrated in sectors such as real estate.
- Central bank challenge: timely recognition of changes in potential output to calibrate monetary policy appropriately and avoid unnecessary FX interventions.

### Key Statistics and Quantitative Points
- FXI in first 9 months of 2024: 2.6 percent of 2023 nominal GDP (almost triple the amount in same period 2023).
- FX market turnover (OTC, 2022 average): Albania yearly turnover 11 billion USD; average among emerging market economies 52 billion USD.
- Share of unhedged FX loans: 50 percent in 2014 → 25 percent in 2024.
- Real estate share of unhedged FX loans in 2024: two-thirds.
- Estimated cumulative exchange rate passthrough: about 0.2 percent impact on headline CPI for a 1-percent appreciation over four quarters.
- Model estimation period: 2009–2024.
- Contribution of non-fundamental shocks to long-run RER variance:
  - 5 percent if FXI reacts to exchange rate movements;
  - around 15 percent if no FX interventions are used.
- Cumulative estimated appreciation due to risk shocks since 2021: around 11 percent.
- Model scenario policy improvement metric: alternative policy delivers a 25 percent improvement over historical policy response in the tourism scenario.

### Role of non-fundamental risk shocks and policy trade-offs (Section 2)
- Risk shocks that widen the UIP “wedge” indicate frictions in international financial markets and may induce a trade-off between output and inflation in Albania according to the estimated model.
- A non-fundamental capital inflow shock that appreciates the exchange rate:
  - Puts downward pressure on inflation.
  - Produces a persistent subsequent rise in output.
- Interest rate policy transmits principally through aggregate demand and therefore moves inflation and output in the same direction; as a result, interest rate policy alone is not ideally suited to addressing the described capital flow shock.

### Effectiveness of sterilized foreign exchange intervention (FXI) (Section 2)
- Sterilized FX intervention (FXI) is presented as a better tool to address temporary inefficient capital flow shocks, conditional on:
  - Markets being sufficiently shallow.
  - An appropriate buffer of reserves being available.
- In the model, FXI is implemented as:
  - An endogenous reaction to the change in the nominal exchange rate.
  - Combined with gradual mean-reversion to restore the desired ratio of reserves to GDP.
- Under an inflow shock that temporarily makes the euro cheap:
  - The FX rule calls for euro purchases.
  - The lek exchange rate appreciation is greatly reduced.
  - The output–inflation trade-off is eliminated in the scenario where FXI is used.
  - Coordinated easing of interest rate policy with FXI could realize greater stabilization benefits.
- Sensitivities and robustness:
  - Quantitative responses depend importantly on the strength with which FX policy responds to the exchange rate.
  - A range of estimates can be obtained using the QIPF model, depending on which historical intervention data are used.
  - Across alternatives considered, FXI is always an effective tool for addressing risk shocks, though quantitative differences in responses may be observed.

### Scenario evidence (Section 2 / Figure 6)
- Figure 6 compares a capital inflow surge under two central bank responses:
  - “With FXI” (leaning against appreciation via FX intervention).
  - “Without FXI” (relying only on interest rate policy).
- Variables illustrated in Figure 6 include:
  - Policy Rate (APR).
  - Output (% trend deviation).
  - Real Exchange Rate (Consumption based).
  - CPI Inflation (APR).
- Figure captions indicate results are based on IMF staff estimates.

### Conclusion and policy considerations (Section 2)
- The exchange rate should continue to play its role as a shock absorber, with FXI reserved to moderate the impact of non-fundamental shocks.
- Application of the quantitative IPF model to Albania indicates:
  - Appreciation of the lek has historically been driven largely by fundamentals.
  - Non-fundamental factors played a modest role in some episodes.
- Policy implications:
  - Consider letting the exchange rate adjust more flexibly and rely on interest rate policy as the primary tool for price stability.
  - In cases of non-fundamental shocks, interventions could be beneficial by lowering output and inflation volatility.
  - Authorities should internalize potential adverse consequences of FXI (and further reserve accumulation), including effects on:
    - Risks to the central bank balance sheet.
    - Interest rate transmission.
    - Financial market development.

*Source: IMF Selected Issues Paper SIP/2025/038 (completed December 17, 2024).*

### Section 1

### Foreign Exchange Intervention Through the Lens of the Quantitative Integrated Policy Framework: The Case of Albania

### Introduction and Context
- IMF’s integrated policy framework (IPF) identifies three frictions that may warrant foreign exchange intervention (FXI): (i) shallow or temporarily illiquid FX markets; (ii) unhedged currency exposures of balance sheets; and (iii) de-anchoring of inflation expectations from high exchange rate pass-through.
- Albania: small open emerging market with inflation targeting; sustained appreciation of the lek amid a tourism boom.
- Bank of Albania (BoA) FX intervention: size of FXI during the first 9 months of 2024 amounted to 2.6 percent of 2023 nominal GDP, almost triple the amount of the same period in 2023.
- FX markets characterized as shallow: yearly turnover of 11 billion USD versus average turnover among emerging market economies of 52 billion USD.
- Sample and document timing: model estimated on quarterly series for Albania over 2009–2024; paper completed on December 17, 2024.

### Key Findings
- Shallow FX markets are the primary IPF friction in Albania that may create a case for FXI.
- The appreciation of the lek has been primarily driven by fundamental factors; conventional interest rate policy is generally the appropriate tool for such fundamental shocks.
- FXI can be an effective complementary tool in certain circumstances where fundamental appreciation is compounded by non-fundamental shocks (e.g., shifts in foreign investor risk appetite), helping to alleviate output-inflation tradeoffs.
- FX mismatches and de-anchored inflation expectations appear broadly contained:
  - Share of unhedged FX loans declined from 50 percent of total loans in 2014 to 25 percent in 2024.
  - Residual risks concentrated in real estate (accounts for two-thirds of unhedged FX loans in 2024).
  - Empirical exchange rate passthrough to headline CPI shows a cumulative impact of about 0.2 percent (for a 1-percent appreciation) over four quarters.
- Inflation expectations are estimated to be well-anchored in the medium and long run.

### QIPF / QIPF Model (Estimated for Albania)
- Model characteristics:
  - New Keynesian open-economy QIPF model tailored to AEs and EMEs; home economy “small” relative to euro area.
  - Extended to include trend productivity growth and a domestic financial sector.
  - Assumes FX intermediaries have limited risk-bearing capacity (as in Gabaix and Maggiori, 2015), which generates realistic exchange rate volatility and implies sterilized FX interventions have real effects.
- Estimation details:
  - Estimated using Bayesian maximum likelihood on a dozen quarterly series for 2009–2024.
  - Euro area block estimated separately; euro area variables included to account for foreign influences.
- Model properties:
  - Nominal exchange rate pass-through to consumer prices is gradual due to local currency pricing-to-market behavior.
  - Interest rate policy gradually adjusts to deviations of expected one-year ahead core inflation from target and activity (output gap) and transmits effectively to prices and the exchange rate relative to output.
  - Preferred specification indicates FX market shallowness: sterilized FX interventions that persistently affect the lek can have sizeable macroeconomic effects on core inflation and activity, particularly if the domestic policy rate is passive.

### Scenario Analysis — Tourism Boom
- Stylized scenario: tourism-driven expansion with higher net exports, stronger domestic demand, appreciation of the real exchange rate; shocks phased in gradually (MIT shocks).
- Central bank realism: policy maker does not have perfect foresight and gradually learns about the evolving increase in potential output.
- Baseline (historic) monetary policy:
  - Monetary policy follows estimated historical policy rule; eases because lek appreciation and productivity improvements reduce inflationary pressures.
  - Potential output rises faster than actual output, causing inflation to fall below target.
- Alternative (discretionary) monetary action:
  - Additional policy rate cuts assumed to offset lek appreciation (for illustration).
  - Result: output gap narrows and inflation moves closer to target while avoiding volatile interest rate movements.
  - Quantified improvement: alternative policy delivers a 25 percent improvement (measured by a standard central bank objective function quadratic in output gap and inflation) over the historical policy response in the scenario.
- Conclusion for tourism (fundamental) shocks:
  - Monetary policy is an appropriate tool; FXI is not necessary for fundamental shocks despite shallow markets.
  - The challenge is recognizing in real time that potential output has risen.

### Risk Shocks, Non-Fundamental Flows, and Policy Trade-offs
- Model allows capital flows driven by non-fundamental (“risk-on”) shocks that impact the real exchange rate through market shallowness.
- Long-run variance decomposition of consumption-based RER:
  - Fundamental shocks are the principal driver.
  - Non-fundamental shocks contributed around 5 percent to long-run RER variance if FXI is reacting to exchange rate movements.
  - Non-fundamental shocks contributed around 15 percent to long-run RER variance assuming no FX interventions are used to lean against exchange rate movements.
- Shorter horizons: risk shocks can have more material effects; since 2021 risk shocks appear to have appreciated the lek by around 11 percent (cumulative contribution in the model’s counterfactual).
- Policy trade-off:
  - Exchange rate volatility driven by non-fundamental factors can create trade-offs between stabilizing output and stabilizing inflation.
  - In such episodes, FXI can be useful to lean against temporary, sentiment-driven capital in- and outflows, complementing conventional monetary and macroprudential tools.

### Policy Implications and Recommendations
- Primary policy tool for fundamental appreciation (e.g., tourism-driven) should be conventional interest rate policy, given its traction on prices and the exchange rate.
- FXI can be justified as a complementary tool when:
  - FX markets are shallow, and
  - Non-fundamental, sentiment-driven capital flows cause outsized and potentially destabilizing exchange rate movements over short horizons.
- Macroprudential measures (MPMs) and targeted microprudential actions are preferable to FXI for addressing remaining FX mismatch risks concentrated in sectors such as real estate.
- Central bank challenge: timely recognition of changes in potential output to calibrate monetary policy appropriately and avoid unnecessary FX interventions.

### Key Statistics and Quantitative Points
- FXI in first 9 months of 2024: 2.6 percent of 2023 nominal GDP (almost triple the amount in same period 2023).
- FX market turnover (OTC, 2022 average): Albania yearly turnover 11 billion USD; average among emerging market economies 52 billion USD.
- Share of unhedged FX loans: 50 percent in 2014 → 25 percent in 2024.
- Real estate share of unhedged FX loans in 2024: two-thirds.
- Estimated cumulative exchange rate passthrough: about 0.2 percent impact on headline CPI for a 1-percent appreciation over four quarters.
- Model estimation period: 2009–2024.
- Contribution of non-fundamental shocks to long-run RER variance:
  - 5 percent if FXI reacts to exchange rate movements;
  - around 15 percent if no FX interventions are used.
- Cumulative estimated appreciation due to risk shocks since 2021: around 11 percent.
- Model scenario policy improvement metric: alternative policy delivers a 25 percent improvement over historical policy response in the tourism scenario.

*Source: IMF Selected Issues Paper SIP/2025/038 (completed December 17, 2024).*

### Section 2

### Section 2 — Exchange Rate Policy, FX Intervention, and Risk Shocks

### Role of non-fundamental risk shocks and policy trade-offs
- Risk shocks that widen the UIP “wedge” indicate frictions in international financial markets and may induce a trade-off between output and inflation in Albania according to the estimated model.
- A non-fundamental capital inflow shock that appreciates the exchange rate:
  - Puts downward pressure on inflation.
  - Produces a persistent subsequent rise in output.
- Interest rate policy transmits principally through aggregate demand and therefore moves inflation and output in the same direction; as a result, interest rate policy alone is not ideally suited to addressing the described capital flow shock.

### Effectiveness of sterilized foreign exchange intervention (FXI)
- Sterilized FX intervention (FXI) is presented as a better tool to address temporary inefficient capital flow shocks, conditional on:
  - Markets being sufficiently shallow.
  - An appropriate buffer of reserves being available.
- In the model, FXI is implemented as:
  - An endogenous reaction to the change in the nominal exchange rate.
  - Combined with gradual mean-reversion to restore the desired ratio of reserves to GDP.
- Under an inflow shock that temporarily makes the euro cheap:
  - The FX rule calls for euro purchases.
  - The lek exchange rate appreciation is greatly reduced.
  - The output–inflation trade-off is eliminated in the scenario where FXI is used.
  - Coordinated easing of interest rate policy with FXI could realize greater stabilization benefits.
- Sensitivities and robustness:
  - Quantitative responses depend importantly on the strength with which FX policy responds to the exchange rate.
  - A range of estimates can be obtained using the QIPF model, depending on which historical intervention data are used.
  - Across alternatives considered, FXI is always an effective tool for addressing risk shocks, though quantitative differences in responses may be observed.

### Scenario evidence (Figure 6)
- Figure 6 compares a capital inflow surge under two central bank responses:
  - “With FXI” (leaning against appreciation via FX intervention).
  - “Without FXI” (relying only on interest rate policy).
- Variables illustrated in Figure 6 include:
  - Policy Rate (APR).
  - Output (% trend deviation).
  - Real Exchange Rate (Consumption based).
  - CPI Inflation (APR).
- Figure captions indicate results are based on IMF staff estimates.

### Conclusion and policy considerations
- The exchange rate should continue to play its role as a shock absorber, with FXI reserved to moderate the impact of non-fundamental shocks.
- Application of the quantitative IPF model to Albania indicates:
  - Appreciation of the lek has historically been driven largely by fundamentals.
  - Non-fundamental factors played a modest role in some episodes.
- Policy implications:
  - Consider letting the exchange rate adjust more flexibly and rely on interest rate policy as the primary tool for price stability.
  - In cases of non-fundamental shocks, interventions could be beneficial by lowering output and inflation volatility.
  - Authorities should internalize potential adverse consequences of FXI (and further reserve accumulation), including effects on:
    - Risks to the central bank balance sheet.
    - Interest rate transmission.
    - Financial market development.

*Source: IMF staff estimates.*

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_Source: https://www.imf.org/-/media/files/publications/selected-issues-papers/2025/english/sipea2025038.pdf_