## Capital Mobility, the Interest Rate-Exchange Rate Relation, and the Choice of Monetary Policy Framework

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---

### Overview and context
- Countries de facto maintaining an exchange anchor represent 42% of those classified by the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER 2018), followed by:
  - other monetary policy frameworks, 24%
  - inflation targeters, 21%
  - monetary targeters, 13%
- Paper focus: monetary policy design and implementation of exchange rate targeters, drawing on lessons from country experiences (detailed country cases: Denmark, Singapore; Czech National Bank case in appendix III).

### Key conceptual points and interest rate parity
- Trilemma (Obstfeld and others 2004): cannot simultaneously fix exchange rate, open capital account, and conduct independent monetary policy.
- Under capital mobility and a credible peg to a single currency, the local interest rate should normally equal the anchor country’s interest rate adjusted with a risk premium (UIP concept).
- Risk premium determinants: transaction costs, liquidity and credit risks, and level of international reserves.
- Benlamine, Laxton, and others (2018): risk premium is inversely related to the international reserve coverage ratio.
- Operational objectives for exchange rate targeters to manage simultaneously:
  - the interest rate differential,
  - the inflation gap relative to anchor country(s),
  - the level of international reserves adequate to support the peg,
  - potential exchange rate misalignments from anticipated anchor currency changes or money/FX market imbalances.

### Operational complications and scenarios
- The overall size of FX flows—related to current and capital account transactions—often drives arbitrage between money and FX markets and shapes monetary transmission; legal degree of capital account openness is less indicative than actual FX flows.
- Scenarios affecting implementability of frameworks:
  - Open capital account but no capital flows.
  - Relatively closed capital account but large FX exposure due to low FX reserves or sizable terms-of-trade (ToT) shocks.
- Policy and operational challenges highlighted:
  - Need for supportive fiscal policy.
  - Strengthened and coherent monetary policy framework.
  - Optimal choice of monetary policy rule.
  - Coherent management of interest rate and exchange rate.
  - Choice of liquidity management framework.

### Literature themes and transition evidence
- Four mainstreams: monetary dynamics under a fixed exchange rate; optimal choice of exchange rate arrangement; transition from fixed to flexible exchange rate; monetary policy rules of exchange rate targeters.
- Optimal arrangement depends on nature of shocks (real vs nominal) and degree of capital mobility (Mundell 1961); floating better for real shocks, fixed may be preferable for nominal shocks.
- Other macro criteria: level of inflation, level of international reserves, fiscal policy flexibility and sustainability.
- Transitions:
  - More likely successful during exchange rate appreciation; harder under depreciation pressures.
  - Smooth transitions aided by monetary and fiscal tightening, strengthening monetary credibility, improving fiscal discipline.
  - Reversals of capital flows (examples cited: GFC, taper tantrum, COVID-19 shock) can force moves to greater exchange rate flexibility.
- IMF literature often omits detailed discussion of interest rate management, monetary policy rules, or liquidity management frameworks when moving to inflation targeting.

### Definitions and distinctions
- Interest rate-based monetary policy: interest rate is main lever to influence aggregate demand and inflation.
- Exchange rate-based monetary policy: exchange rate is main lever used to stabilize inflation; management of short-term interest rates is normally subordinate and set to support a target exchange rate.
- Distinct from interest-rate based policy with FX interventions: there the interest rate is primary tool and FX interventions smooth exchange rate volatility.

### Country cases — operational features and lessons
- Denmark (Danmarks Nationalbank peg to the euro)
  - Fixed exchange rate policy since early 1980s; since 1999 against the euro.
  - ERM II central rate: 746.038 krone per 100 euro, fluctuation band: +/- 2.25 percent.
  - DNB policy rates are geared to management of the exchange rate and cannot be used for business cycle management.
  - Liquidity management focuses on sizing bank accounts to ensure sufficiency for money market and payment system functioning and financial stability.
  - Interaction with ECB: when no FX market pressures exist, DNB usually changes interest rates in step with ECB policy interest rates; for short-term fluctuations DNB intervenes in FX market and may adjust policy rate spread vis-à-vis euro area if interventions insufficient.
  - Crisis responses:
    - After GFC October 2008: DNB increased policy rate spread and sold FX reserves; in 2009 gradually reduced spread and accumulated FX reserves.
    - Early 2015: massive capital inflows and appreciation pressure after Switzerland abandoned its quasi-peg triggered substantive interventions in January–February 2015; deposit rate reduced to -0.75 percent; CDs reached -0.75 percent on February 6, 2015.
  - DNB operational tools and limits:
    - Current-account limits for counterparties (examples preserved): each counterparty limit = 3 percent of its deposits up to DKK 2 billion and 1.7 percent on deposits above 2 billion; mortgage credit institutions limit DKK 500 million.
    - Standard OMOs: weekly OMOs, daily OMOs (CDs), liquidity adjusting operations; no marginal lending facility; money market rates can rise freely to dampen FX outflows.
  - ERM II context note: until very recently Danish kroner the only ERM II participant; Bulgarian lev and Croatian kuna joined ERM II on July 13, 2020.
- Singapore (Monetary Authority of Singapore — MAS exchange rate-based policy)
  - Primary objective: price stability with exchange rate as anchor.
  - MAS manages SGD against a trade-weighted basket within a target band; framework known as BBC (Band, Basket, Crawl).
    - The basket: currencies weighted by trade shares.
    - The policy band: NEER can fluctuate within a band; level and slope announced semi-annually.
    - The crawl: periodic review; band incorporates a crawl feature.
  - Communication: while composition and numerical BBC parameters are undisclosed, MAS announces targeted path changes (examples preserved: January 2015 “slope of the policy band will be reduced”; April 2016 “zero rate of appreciation”; October 2016 “zero appreciation maintained for an ‘extended period’”); prevailing weekly NEER published with about one month lag.
  - Intervention triggers: NEER reaches band edge or undue volatility/speculation; MAS may intervene before band edge or allow breach before intervening but generally refrains from unnecessary interventions.
  - Liquidity management: ensure sufficient but not excessive liquidity; daily operations guided by autonomous liquidity factor forecasts; instruments: direct borrowing/lending, FX swaps, repos, MAS bills; standing two-sided discount window for RTGS participants; rates market-determined.
  - Crisis responses:
    - Mid-September 1985 speculative attack: MAS sold USD and left intervention unsterilized to maintain banking system liquidity in line with autonomous factors.
    - Onset of GFC 2007: MAS left more liquidity in system to alleviate funding tightness, later withdrew excess in 2011–12 as markets stabilized.
- Czech National Bank (temporary exchange rate floor — Appendix III)
  - AREAER 2018 classifies Czech monetary framework as IT and exchange rate arrangement as floating.
  - November 7, 2013: CNB announced a floor of 27 koruna to the euro to achieve additional monetary easing when interest rates hit the lower bound.
  - CNB had lowered interest rates to 0.05 percent in late 2012 and committed to maintain that level as long as necessary.
  - CNB ended exchange rate commitment in April 2017.
  - After exit, FX reserves stock reached 70% of GDP.
  - CNB started to raise interest rates gradually in August 2017.
  - Objectives: weaken koruna to prevent deflation and ensure fulfillment of 2 percent inflation target; exchange rate commitment mitigated disinflationary shock and supported recovery (economic growth 2 percent in 2014).
  - Inflation: slight overshoot in 2017 with inflation in upper half of tolerance band; inflation remained above 2 percent in 2017 and returned to target in late 2018.

### Monetary policy rules for exchange rate targeters
- When exchange rate is clearly and officially pegged:
  - UIP-based interest rate rule:
    - i_t = i_t^* + Prem_t
  - Forward-looking interest rate rule including foreign policy rate (TR + i_t^*):
    - i_t = α_1 i_t^* + α_2 i + α_3 (E[π_{t+n} | Ω_t] − π_T) + α_4 (E[y_t | Ω_t] − y_T)
      - where i is long-run equilibrium nominal interest rate; π_{t+n} is inflation between t and t+n; π_T is inflation target; y_t is real output; y_T is potential output; E expectation operator; Ω_t information set.
- When exchange rate is stabilized/tightly managed/being adjusted:
  - Forward-looking ER rule (ERR):
    - Δe_t = γ Δe + α (E[π_{t+n} | Ω_t] − π_T) + β (E[y_{t+n} | Ω_t] − y_T)
- UIP+TR combination when prior rules do not provide guidance for policy rate:
  - i_t = g UIP + (1−g) TR
  - Interpretation:
    - Pure UIP reaction function: policy rate reacts to anchor country monetary policy only (example: Denmark).
    - TR + i_t^* allows pass-through to output and inflation; extends Clarida, Galí, Gertler (1998) to include foreign rate.
  - Historical implication: pre-1992 EMS countries implicitly including Bundesbank policy rate (TR + i_t^*) led to relatively high real short-term interest rates even during low inflation; sizable capital flows during EMS crisis forced higher policy rates to counterbalance outflows, creating dilemma between hiking rates and depleting FX reserves within +/-2.25% bands.
- Morocco MQPM (example of UIP+TR):
  - i_t = ω_ip ip_t + (1−ω_ip) iuip_t
  - ip_t = α_1 ip_{t−1} + (1− α_1)( ip_t + α_2 π_{t+3}^{dev} + α_3 \hat{dd}_t) + ε_{t,ip}
  - iuip_t = i_t^{ez} + Prem_t + (E_t(MAD/EUR_{t+1}) – MAD/EUR_t )
  - Variable definitions preserved exactly from source.

### Liquidity management under an exchange rate anchor
- Corridor system introduction:
  - A corridor system can be compatible with fixed exchange rate regimes (example: Morocco introduced an interest rate mid-corridor under a peg to a currency basket while maintaining selected capital controls).
  - Dichotomy principle (Bindseil 2016): separate macroeconomic analysis for setting policy rate from operational process stabilizing short-term money market rate.
- Preconditions for successful mid-corridor under an exchange rate anchor:
  - (1) adequate liquidity forecasting framework;
  - (2) active interbank market;
  - (3) clear separation between monetary policy operational framework and emergency liquidity assistance (ELA);
  - (4) relatively developed fixed income markets providing eligible collateral and longer-term funding instruments;
  - (5) absence of high levels of speculation against the local currency.
- Corridor versus floor systems:
  - Drawbacks of a floor system: draining surplus liquidity mainly overnight at banks’ initiative can be almost equivalent to leaving free reserves, exerting pressure on international reserves and the peg.
  - Mid-corridor features: unique overnight standing lending facility (ceiling) and overnight standing deposit facility (floor); standard OMOs can be set at longer maturities to foster market development.
  - Full-allotment in liquidity-providing OMOs may lead to over-injection of liquidity that increases demand for FX at the central bank, pressuring FX reserves.
- Tiering floor systems:
  - Tiering applies different interest rates to counterparties’ reserves to limit demand for reserves and support money market functioning (examples: Central Bank of Norway since 2011, Swiss National Bank, Bank of Japan, ECB).
  - Under a tiered floor, objective is to avoid large freely available deposits that could be used for speculation while ensuring day-to-day liquidity.
- DNB operational practices (summarized):
  - Weekly OMOs: monetary policy loans against collateral (at lending rate).
  - Daily OMOs: offers to buy/sell CDs maturing on last banking day of week; premium added to CDs’ interest rate to incentivize interbank exchange.
  - Liquidity adjusting operations: deposits, lending against collateral, FX swaps, via auction or bilateral transactions.
  - From mid-2009 to early 2020, net liquidity position of counterparties significantly positive; three-year monetary policy loans introduced early 2012 to increase long-term funding.

### Policy inconsistencies and macro consequences
- Identified policy inconsistencies under an exchange rate anchor:
  1. Inconsistency between banking system liquidity management and the exchange rate.
  2. Inconsistency between anchor currency movements and balance of payments developments.
  3. Inconsistency between fiscal policy and the exchange rate arrangement.
- Mechanisms and consequences:
  - Quantitative liquidity injections under a fixed or tightly managed exchange rate can increase demand for FX and place pressure on international reserves if not sterilized.
  - Unsterilized liquidity surpluses can destabilize money and FX markets, stimulate FX demand and speculation, and weaken anchor sustainability.
  - Pegging to an appreciating anchor mechanically appreciates local currency and can be inconsistent with adverse current account shocks.
  - Depreciation of anchor currencies (examples: US dollar after GFC 2007–08; euro during euro area crisis 2011) raises speculation risk and complicates liquidity management.
  - Monetary policy under an exchange rate anchor requires fiscal discipline; fiscal dominance increases likelihood the anchor becomes unsustainable.
- Success factors: strong economic fundamentals and credible policies.

### Transitioning the exchange rate arrangement
- Sustainability conditions for exchange rate anchors:
  - Adequate international reserves and sometimes an increasing NFA path; preferably a stream of current account surpluses.
  - When NFA are depleted or persistently decreasing, regimes become prone to speculation and unsustainable.
- Paths to greater flexibility:
  - Gradual transitions (examples: Chile, Israel, Poland) or rapid/disorderly moves under pressure (examples: Brazil, Czech Republic, Uruguay).
  - Transitional arrangements: single-currency peg → peg to basket → BBC (Band, Basket, Crawl) → crawling arrangements → gradual widening of bands.
- Monetary policy rule adjustments during transition:
  - If interest rate pass-through to inflation is evident, adopt TR or TR+UIP.
  - If pass-through is absent/weak, adopt an ERR.

### Key conclusions and policy implications (guiding principles)
- Conceptual distinctions:
  - Exchange rate-based monetary policy differs from interest rate-based policy with FX interventions: in the former the exchange rate is the nominal anchor and main instrument for stabilizing inflation.
- Coherence required:
  - Short-term interest rate and exchange rate are tied by interest rate parity and should be managed coherently to achieve price stability.
- Role of policy rate:
  - Policy rate may aim at objectives other than business cycle smoothing; monetary policy rules under exchange rate anchors can differ from standard forward-looking Taylor-type rules.
- Liquidity management importance:
  - Liquidity management should stabilize money market rates, anchor market expectations, curtail surpluses, and limit over-injection of central bank liquidity that pressures reserves and the exchange rate.
- Institutional and fiscal discipline:
  - Exchange rate anchors prone to policy inconsistencies; require fiscal and monetary discipline and are hardly compatible with fiscal dominance.
- Transition strategy:
  - Anchor becomes unsustainable when international reserves are depleted; move to interest rate-based policy is often gradual and may be supported by adopting an interest rate corridor with steady narrowing of corridor width.
- Operational choices under pressures:
  - Corridor systems easier to introduce under partial capital controls or absent highly speculative pressures; tiering floor systems may be envisaged when facing sizeable capital flows.

### Appendix I — country composition and AREAER 2018 classification figures (preserved exactly)
- Exchange rate anchor, 81, 42%
- Monetary aggregate target, 24, 13%
- Inflation targeting framework, 41, 21%
- Other, 46, 24%
- No separate legal tender, 13, 16%
- Currency board, 11, 13%
- Conventional peg, 41, 51%
- Stabilized arrangement, 8, 10%
- Crawling peg, 3, 4%
- Crawl-like arrangement, 1, 1%
- Other managed arrangement, 4, 5%
- Soft peg breakdown examples:
  - Conventional pegs: pegged to the euro (18 countries), pegged to the US dollar (14 countries); five pegs to other currencies (Bhutan, Eswatini, Lesotho, Namibia, Nepal); four pegged to a basket (Fiji, Kuwait, Libya, Morocco).
  - Stabilized arrangements: 8 countries (Guyana, Lebanon, Maldives, Trinidad and Tobago stabilize against the USD; Croatia and North Macedonia stabilize against the euro; Singapore and Vietnam stabilize against a composite).
  - Crawling peg: Botswana, Honduras, Nicaragua (3).
  - Crawl-like arrangement: Iran (1).
- Appendix II exchange rate anchor counts (preserved):
  - Exchange Rate Anchor (57) by anchor currency:
    - US Dollar (20)
    - Euro (20)
    - Composite (8)
    - Other (5)
  - Conventional peg (41) — country list preserved in source.
  - Stabilized arrangements (8) — country list preserved in source.
  - Crawling peg (3) — Honduras, Nicaragua, Botswana.
  - Crawl-like arrangement (1) — Iran.
  - Pegged exchange rate within horizontal bands — none listed.

*Source: IMF working paper — "Capital Mobility, the Interest Rate-Exchange Rate Relation, and the Choice of Monetary Policy Framework" (sections I–IV and Appendices I–V excerpts as provided).*

### 1. Capital Mobility, the Interest Rate-Exchange Rate Relation, and the Choice of Monetary

### 1. Capital Mobility, the Interest Rate-Exchange Rate Relation, and the Choice of Monetary Policy Framework

### Overview and context
- Countries de facto maintaining an exchange anchor represent 42% of those classified by the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER 2018), followed by other monetary policy frameworks (24%), inflation targeters (21%), and monetary targeters (13%).
- Some exchange rate targeters are attempting to move toward further exchange rate flexibility, while others have preferred to settle in an exchange rate anchoring framework (examples cited: Denmark, Singapore, and the Gulf Cooperation Council (GCC) countries).
- Paper focus: monetary policy design and implementation of exchange rate targeters, drawing on lessons from country experiences.

### Key conceptual points
- Trilemma (Obstfeld and others 2004): countries cannot simultaneously fix their exchange rate, open their capital account, and conduct an independent monetary policy.
- In practice, many central banks with fixed exchange rates set the level of their policy rate even under capital mobility (El Hamiani Khatat and Veyrune 2019).
- The Trilemma does not explain how the interest rate can be used to achieve a certain level of the exchange rate rather than inflation, while the exchange rate can be used as the main instrument to stabilize inflation.

### Interest rate parity and risk premium
- Under capital mobility and a credible peg to a single currency, the local interest rate should normally equal the anchor country’s interest rate adjusted with a risk premium.
- Risk premium determinants: transaction costs, liquidity and credit risks, and level of international reserves.
- Benlamine, Laxton, and others (2018): risk premium is inversely related to the international reserve coverage ratio.

### Operational complications for exchange rate targeters
- Monetary policy must manage:
  - the interest rate differential,
  - the inflation gap relative to anchor country(s),
  - the level of international reserves adequate to support the peg,
  - potential exchange rate misalignments from anticipated anchor currency changes or money/FX market imbalances.
- The overall size of FX flows—related to current and capital account transactions—rather than the legal degree of capital account openness, often drives arbitrage between money and FX markets and shapes monetary transmission.
- Scenarios:
  - Open capital account but no capital flows.
  - Relatively closed capital account but large FX exposure due to low FX reserves or sizable terms-of-trade (ToT) shocks.

### Policy and operational challenges addressed in the paper
- Need for supportive fiscal policy.
- Strengthened and coherent monetary policy framework.
- Optimal choice of monetary policy rule.
- Coherent management of interest rate and exchange rate.
- Choice of liquidity management framework.

---

### Literature review — main themes
- Four mainstreams in literature on exchange rate targeting:
  1. Monetary dynamics under a fixed exchange rate.
  2. Optimal choice of exchange rate arrangement.
  3. Transition from a fixed to a more flexible exchange rate.
  4. Monetary policy rules of exchange rate targeters.

#### Optimal choice of exchange rate arrangement
- Optimal arrangement depends on nature of shocks (real vs nominal) and degree of capital mobility (Mundell 1961).
- Floating exchange rate insulates against real shocks (for example, ToT shocks); fixed exchange rate may be preferable for nominal shocks.
- Optimal currency area criteria (Mundell 1961; McKinnon 1963; Kenen 1969): shock symmetry, degree of openness, degree of labor mobility, ability to make fiscal transfers.
- Other macro criteria: level of inflation, level of international reserves, fiscal policy flexibility and sustainability.
  - High inflation can constrain ability to maintain peg to low-inflation anchor.
  - Without adequate international reserves, authorities may not be able to maintain a peg.
  - Fiscal flexibility is more important under a peg since exchange rate cannot be a shock absorber.
- Policy/institutional criteria matter: countries may adopt pegs to “borrow” credibility when institutional capacity for flexible regimes is undeveloped (Levy-Yeyati and Struzenegger 2010; El Hamiani Khatat and Veyrune 2019).
- Calvo and Mishkin (2003): choice of exchange rate arrangement is likely second-order relative to development of good fiscal, financial, and monetary institutions for macro success in emerging markets.

#### Transition from fixed to more flexible exchange rates
- Successful transitions are more likely during periods of exchange rate appreciation; harder under depreciation pressures.
- Smooth transitions are aided by monetary and fiscal tightening, strengthening monetary credibility, and improving fiscal discipline.
- Fixed regimes are vulnerable to currency crises—speculative attacks often follow expansionary monetary policies that raise inflation, overvaluation, and external imbalances.
- Reversals of capital flows (examples: GFC, taper tantrum, COVID-19 shock) can force moves to greater exchange rate flexibility.
- IMF literature stresses need for transitional arrangements when moving to inflation targeting (IT) but often omits detailed discussion of interest rate management, monetary policy rules, or liquidity management frameworks under an exchange rate anchor.

#### Monetary targeting (MT) and exchange rate anchors
- In MT regimes, implementation relies on central bank control over reserve money (Laurens and others 2015).
- Under an exchange rate anchor, conventional MT can be challenging because money is primarily endogenous and reserve/base components can be dominated by autonomous liquidity factors (e.g., currency in circulation).
- FX reserves accumulation produces positive liquidity shocks under constrained exchange rate moves; reversals can force changes in reserve requirements, liquidity injections, or policy rate hikes.
- Persistent adverse shocks can make pressures on FX reserves, liquidity conditions, and eligible collateral unsustainable, necessitating greater exchange rate flexibility.

#### Monetary policy rules of exchange rate targeters
- Benlamine, Laxton and others (2018): quarterly projection model (QPM) for Morocco allowing switch from fixed to flexible exchange rate; differences captured in UIP and Taylor Rule equations; need for reassessment and recalibration of MQPM to reflect long-term behavioral changes under flexibility.
- Parrado (2004): Monetary Authority of Singapore's rule identified as an exchange rate rule (ERR); MAS policy is forward-looking aimed at stabilizing inflation and output, with framework centered on managing exchange rate and price stability as primary objective.
- This paper focuses on principles of interest rate parity and the dichotomy between policy decisions and implementation among exchange rate targeters, rather than a comprehensive review of monetary policy rules.

---

### Definitions and distinctions
- Interest rate-based monetary policy: interest rate is the main lever to influence aggregate demand and inflation.
- Exchange rate-based monetary policy: exchange rate is the main lever used to stabilize inflation; management of short-term interest rates is normally subordinate and set to support a target exchange rate.
- Difference from interest-rate based policy with FX interventions: in the latter, interest rate is primary tool and FX interventions smooth exchange rate volatility; in exchange rate-based framework, exchange rate is primary instrument.

### Coverage of country cases in paper
- Country case studies in the paper: Denmark and Singapore are covered in detail in the main text.
- The Czech National Bank (CNB) case—temporary implementation of an exchange rate floor within an inflation targeting framework—is explained in appendix III.
- Note: the Czech Republic conducts monetary policy within an inflation targeting framework, in contrast to Denmark and Singapore.

*Source: IMF working paper — "Capital Mobility, the Interest Rate-Exchange Rate Relation, and the Choice of Monetary Policy Framework" (sections I–III as provided).*

### 1998. The AREAER 2018 classifies the monetary policy framework of the Czech Republic

### 1998. The AREAER 2018 classifies the monetary policy framework of the Czech Republic

### Classification and exceptional measures: Czech Republic
- The AREAER 2018 classifies the monetary policy framework of the Czech Republic as IT and its exchange rate arrangement as floating.
- Between November 2013 and April 2017, a floor on the koruna exchange rate was maintained as an exceptional tool to achieve further monetary policy easing in a situation when interest rates reached the lower bound.
- The extraordinary measure aimed at delivering the required monetary policy stance to prevent the deflation threat.
- After the introduction of the floor:
  - The AREAER 2014 classified the exchange rate arrangement of the Czech Republic as “other managed arrangement”.
  - One year later the exchange rate arrangement was classified as a “stabilized arrangement”.
  - The monetary policy framework of the Czech Republic remained classified as IT.

### Capital mobility, FX flows, and the choice of monetary policy framework
- The material presents a conceptual linkage between capital mobility / size of FX flows and the relative roles of interest rate-based monetary policy versus exchange rate-based monetary policy (Figure 1).
- High capital mobility / large FX flows tend to make interest rate-based monetary policy more feasible; shallow FX flows or capital controls tend to make exchange rate-based monetary policy relatively more implementable.
- The charting implies central bank responses range from pure interest rate-based frameworks to explicit ER targeting, with intermediate mixed strategies.

### A. Denmark: Danmarks Nationalbank peg to the euro — operational features and experience
- Denmark has pursued a fixed exchange rate policy since the early 1980s; since 1999 against the euro.
- Denmark participates in ERM II at a central rate of 746.038 krone per 100 euro, with a narrowed fluctuation band of +/- 2.25 percent.
- Within this framework:
  - DNB policy rates are geared to management of the exchange rate and cannot be used for business cycle management.
  - Liquidity management focuses on sizing bank accounts to ensure sufficiency of liquidity in support of money market and payment system functioning, and financial stability.
- Interaction with the ECB:
  - When no FX market pressures exist, DNB usually changes interest rates in step with ECB policy interest rates.
  - For short-term fluctuations, DNB intervenes directly in the FX market.
  - If FX interventions are insufficient, DNB may adjust the policy rate spread vis-à-vis the euro area to impact capital flows.
- Crisis experience and policy actions:
  - Following the GFC in October 2008, the DNB increased the policy rate spread and sold FX reserves; in 2009 the DNB gradually reduced the policy rate spread and accumulated FX reserves.
  - In early 2015, massive capital inflows and appreciation pressure after Switzerland abandoned its quasi-peg triggered substantive interventions in January and February 2015.
  - At that time DNB abstained from further interest rate reductions given an already low policy rate (deposit rate reduced to -0.75 percent) and negative policy rate spread.
  - Between April 25 and September 4, 2014, the DNB temporarily moved the interest rate of its certificates of deposits (CDs) to positive levels before starting a reduction cycle; CDs reached a level of -0.75 percent on February 6, 2015.
- ERM II context:
  - Until very recently, the Danish kroner has been the only ERM II participant; the Bulgarian lev and the Croatian kuna joined ERM II on July 13, 2020.

### B. Singapore: MAS exchange rate-based monetary policy — design and implementation
- Primary objective: price stability with the exchange rate as the monetary policy anchor.
- The MAS manages the Singapore dollar against a trade-weighted basket of currencies of Singapore’s major trading partners within a target band; the composition of the basket is revised periodically.
- Core features of the MAS BBC (Band, Basket, Crawl) framework:
  1. The basket: currencies assigned different weights depending on Singapore’s trade share with each country.
  2. The policy band: NEER can fluctuate within a policy band; the level and slope of the band are announced semi-annually.
  3. The crawl: the band is periodically reviewed and incorporates a crawl feature to reflect the continuous assessment of the exchange rate path.
- Communication and disclosure:
  - By announcing a targeted path for the NEER, whose composition is undisclosed, the MAS signals the policy stance.
  - The MAS does not disclose numerical values of BBC parameters or their changes; for example:
    - The January 2015 interim monetary policy statement said “the slope of the policy band will be reduced”.
    - The April 2016 statement announced a zero rate of appreciation for the policy band.
    - The October 2016 statement clarified that zero appreciation would be maintained for an “extended period.”
  - The MAS publishes the prevailing level of the weekly NEER with a lag of about a month.
- Operational intervention triggers:
  - FX interventions are triggered when (1) the NEER reaches the edge of the policy band on either side; or (2) there is undue volatility or speculation against the currency.
  - The MAS may intervene before the band is reached or allow the NEER to breach the band before intervening, but generally refrains from unnecessary interventions.
- Liquidity management:
  - Aims to ensure sufficient but not excessive liquidity to meet banks’ precautionary and settlement balances.
  - MAS conducts daily liquidity management operations guided by autonomous liquidity factors forecasts, and exclusively with primary dealers.
  - Instruments include direct borrowing or lending, FX swaps, repurchase agreements (repos), and MAS bills.
  - MAS operates a standing facility (two-sided discount window) for real time gross settlement participants; borrowing and lending rates are market-determined.
- Crisis responses:
  - Mid-September 1985 speculative attack: MAS intervened in FX market to sell US dollars and left the intervention unsterilized to maintain banking system liquidity in line with autonomous factors.
  - At the onset of the GFC in 2007, MAS left more liquidity in the domestic banking system to alleviate tightness in funding markets, and subsequently withdrew some excess in 2011–12 when financial markets stabilized.

### IV. The exchange rate as the main monetary policy instrument
- One Instrument, One Target:
  - Countries peg or tightly manage exchange rates to accumulate FX reserves, preserve competitiveness, and curtail inflationary pressures when alternative nominal anchors are absent.
  - Exchange rate dominance is more common in developing and emerging market economies where pass-through from the exchange rate to inflation is typically higher.
  - Managing the exchange rate can be achieved via discretionary or rule-based FX interventions, or via policy rate adjustments to influence the exchange rate.
  - Fully discretionary policies provide flexibility but may undermine credibility and risk misusing the exchange rate for objectives other than inflation.
  - When the exchange rate is the main instrument, its role and objective should be clearly explained and communicated to the public.

### B. One anchor currency versus multiple currency basket
- Anchoring to a basket reduces misalignment risk when major changes in a single anchor currency are expected.
- A single-currency anchor exposes the targeter to fluctuations of the dominant anchor currency and can disrupt macroeconomic balance.
- Rigidly fixed exchange rates to an unchanged basket may produce distortions when anchor currency moves are inconsistent with fundamentals or when exogenous shocks occur.
- Historical example:
  - Early 1980s: US dollar appreciation while the Singapore dollar tracked the US dollar closely resulted in loss of competitiveness for Singapore-based companies relative to firms in countries whose currencies weakened against the US dollar.

### C. Multiple supply and demand factors of foreign exchange
- For exchange rate targeters with shallow financial markets, main FX supply/demand drivers are trade balance transactions and remittances, which may not translate into central bank flows.
- FX holdings can remain within firms, households, and commercial banks depending on surrender requirements and exchange rate arrangement; depreciation expectations can lead agents to retain larger FX amounts.
- Extreme cases can lead to dollarization if monetary policy framework credibility and exchange rate arrangement are weak.
- When financial markets are developed and capital controls absent, covered interest rate arbitrage allows banks/clients to arbitrage between anchor and local markets; credit risk considerations apply.
- During the euro area sovereign crises, investors reinvested liquidities in lower credit risk countries such as Denmark or Switzerland, prompting those central banks to decrease policy rates to reduce appetite for their assets.

### D. Policy inconsistencies and their consequences
- Identified types of policy inconsistencies under an exchange rate anchor:
  1. Inconsistency between banking system liquidity management and the exchange rate.
  2. Inconsistency between anchor currency movements and balance of payments developments.
  3. Inconsistency between fiscal policy and the exchange rate arrangement.
- Quantitative liquidity injections under a fixed or tightly managed exchange rate can increase demand for FX and place pressure on international reserves if not sterilized.
- Unsterilized liquidity surpluses can destabilize money and FX markets, stimulate FX demand and speculation, and weaken exchange rate anchor sustainability.
- Pegging to an appreciating anchor currency mechanically appreciates the local currency, which can be inconsistent with adverse current account shocks and cause imbalances.
- When anchor currencies depreciate (e.g., US dollar after the GFC 2007–08; euro during euro area crisis 2011), exchange rate targeters face higher speculation risk and more complicated liquidity management.
- Monetary policy under an exchange rate anchor requires fiscal discipline to prevent current account imbalances and pressures on international reserves; fiscal dominance increases the likelihood that the anchor becomes unsustainable.
- Success of exchange rate anchors depends on strong economic fundamentals and credible policies.

### Indicators and comparative evidence
- The material provides comparative macroeconomic indicators for selected exchange rate targeters (Denmark and Singapore), including:
  - Fiscal Balance (percent of GDP)
  - Public Debt (percent of GDP)
  - Current Account Balance (percent of GDP)
  - Annual CPI Inflation (percent)
- Note: The Singapore Government does not borrow to fund its budget. Government debt issuance aims to deepen the domestic market, meet Central Provident Fund investment needs, and provide a long-term savings option; all borrowing proceeds from bond issuance are invested.

### Transition to guiding principles
- The text concludes that addressing potential inconsistencies confronting exchange rate targeters requires specific recommendations.
- It introduces the upcoming section (V) on the monetary policy framework of exchange rate targeters and notes that sound monetary policy design and implementation usually involves six processes (Figure 6).

*Source: wpiea2020180-print-pdf - 1998. The AREAER 2018 classifies the monetary policy framework of the Czech Republic.*

### 1. Choice of the monetary policy

### 1. Choice of the monetary policy

### Determinants of the monetary policy framework choice
- The choice depends on:
  - (1) the level of international reserves, and pressures on the external accounts;
  - (2) the composition of reserve money and structural liquidity position of the banking system;
  - (3) the soundness and level of development of the financial sector including its institutions and markets and its overall ability to transmit the monetary policy stance to the real economy;
  - (4) the nature of fiscal financing, fiscal dominance risks, and their implications for banking system liquidity and government bond market development;
  - (5) the central bank governance, mandate, decision-making process and capacity.
- Beyond independence (institutional, financial, and organizational), the central bank’s technical and analytical capacities are critical for choosing the monetary policy framework.

### Required analysis, modeling, and decision processes
- The central bank needs:
  - thorough macro-financial analysis regardless of the nominal anchor;
  - a clear understanding of inflation and exchange rate expectations of economic agents;
  - to decide on its policy rate, exchange rate, or reserve money;
  - to develop analytical and modeling capacities and produce reliable macroeconomic and inflation forecasts.
- Decision-making involves several committees and entities within the central bank and requires internal and external communication of decisions, underlying assumptions, scenarios, and risk factors.
- Operational implementation consists of:
  - (1) designing liquidity management operations to align a short-term money market rate (secured or unsecured) with the policy rate or to maintain bank reserves consistent with the reserve money path;
  - (2) calibrating the volume of monetary operations to achieve the operational target of monetary policy.
- For exchange rate targeters, operational implementation includes FX interventions to fix, stabilize, or manage the exchange rate.
- Communication is needed to anchor inflation expectations and market expectations; sound central bank communication affects inflation expectations, exchange rate developments, FX markets, and market participants’ behavior.
- Evaluation of monetary policy is needed to assess the suitability of decisions and the overall monetary policy framework.

### Institutional prerequisites for an exchange rate anchor
- The FX policy and its operational implementation should be a core mandate of the central bank and clearly specified in its law; delegating exchange rate management to the fiscal authority constrains the central bank’s ability to fulfill its inflation objective and its flexibility in using main monetary policy instruments.
- Fiscal policy should be supportive to avoid threatening framework sustainability; current account and fiscal surpluses are important for the viability of an exchange rate anchor, supporting currency appreciation trends and FX reserves accumulation.

### Guiding principles for monetary policy design and implementation with an exchange rate anchor
- The exchange rate should preferably target one main objective: inflation. Preparation includes strengthening the central bank’s:
  - (1) ability to assess exchange rate misalignments;
  - (2) modeling and macroeconomic forecasting capacity to implement a forward-looking monetary policy;
  - (3) monitoring and management of banking system liquidity.
- Price stability (inflation) is the ultimate objective of the exchange rate targeter while the exchange rate is the nominal anchor and the main monetary policy instrument.
- An assessment of monetary transmission and inflation determinants should precede the choice of the monetary policy rule and guide decisions; the reaction function should reflect empirical assessment results rather than mechanically linking the policy rate to an inflation target when evidence does not support such a link.
- Setting/changing the policy rate and stabilizing money market rate fluctuations are distinct processes: stabilizing short-term money market fluctuations is operational fine-tuning, while the level of the policy rate is usually decided by the central bank board or MPC according to a policy rule embedded in a core projection model supported by other forecasting tools.
- The interest rate should be managed coherently with the exchange rate; the monetary policy rule under an exchange rate anchor can differ from a standard forward-looking TR.
- Liquidity management should aim at preventing persistent and large liquidity surpluses and avoid quantitative measures or over-injection of central bank liquidity when these may destabilize the exchange rate.
- Central bank communication should focus on market considerations beyond macroeconomic conditions to prevent unnecessary market volatility; greater transparency fosters market discipline, but there is a limit to transparency at the operational level. The FX policy and objectives of FX intervention should be transparent, while some ex-ante secrecy around FX interventions may be retained.

### Lessons from monetary policy transmission under exchange rate anchors
- The interest rate channel is typically the main transmission channel, where expansionary policy lowers short-term rates, depreciates the exchange rate, and stimulates aggregate demand.
- Central banks operating exchange rate anchors may not always control liquidity conditions and short-term interest rates effectively; they may leave FX intervention-generated liquidity surpluses unsterilized or sterilize them at very low interest rates.
- Factors weakening the interest rate channel include:
  - central banks not implementing fully conventional market-based monetary policy aligning a short-term money market rate with a key policy rate;
  - fragmented liquidity management frameworks using multiple operations and policy rates that undermine monetary policy signaling;
  - absence of an active interbank uncollateralized or repo market, and/or no deep domestic sovereign bond market preventing transmission from central bank short-term rate actions to market rates and the yield curve;
  - reluctance or inability to sterilize liquidity surpluses at appropriate interest rates due to sterilization cost concerns, producing downward pressures on short-term rates and widening gaps with long-term rates;
  - inadequate liquidity forecasting and management frameworks leading to miscalibrated monetary operations that can add shocks to the system;
  - in highly troubled banking systems, short-term rates may reflect financial stability issues more than macroeconomic conditions.
- In the presence of an impaired interest rate channel, central bank actions on the exchange rate may be more effective in stabilizing inflation than actions on interest rates.

### Central bank monetary policy rules under exchange rate anchors
- Four monetary policy rules are identified depending on how the central bank manages the exchange rate anchor.

When the exchange rate is clearly and officially pegged:
- 1. An interest rate rule including the policy rate of the anchor country i_t^* and a risk premium Prem_t (UIP condition):
  - i_t = i_t^* + Prem_t                            (1)
- 2. A forward-looking interest rate rule including the policy rate of the anchor country as well as inflation and output gaps (TR + i_t^*):
  - i_t = α_1 i_t^* + α_2 i + α_3 (E[π_{t+n} | Ω_t] − π_T) + α_4 (E[y_t | Ω_t] − y_T)       (2)
    - where i is the long-run equilibrium nominal interest rate, π_{t+n} is the inflation rate between periods t and t+n, π_T is the inflation target, y_t is real output, y_T is potential output, E is the expectation operator, and Ω_t the information available at the central bank at the time it sets the policy rate.

When the exchange rate is stabilized, tightly managed, or being adjusted:
- 3. A forward-looking ER rule (ERR) where the change in the nominal effective exchange rate (NEER), e_t, substitutes the interest rate in the TR:
  - Δe_t = γ Δe + α (E[π_{t+n} | Ω_t] − π_T) + β (E[y_{t+n} | Ω_t] − y_T)       (3)

*Source: wpiea2020180-print-pdf*

### 4. Since the previous rule, does not provide guidance for the policy rate, an interest rate rule

### 4. Since the previous rule, does not provide guidance for the policy rate, an interest rate rule can still be specified as a combination of a UIP condition and TR (UIP+TR)

### UIP+TR specification and interpretation
- Formal specification:
  - i_t = g UIP + (1−g) TR          (4)
- Interpretation:
  - A UIP condition as the reaction function assumes the policy rate does not react to the business cycle but only to the monetary policy of the anchor country (example: Denmark).
  - TR+i_t^∗ assumes some degree of influence/pass-through of the policy rate to output and inflation.
  - The TR including the foreign interest rate (TR+i_t^∗) extends the Clarida, Galí, and Gertler (1998) reaction function to include the foreign interest rate when the central bank participates in an exchange rate system.
- Historical implications:
  - For France, Italy, and the United Kingdom before the EMS crisis in 1992, the reaction function implicitly including the Bundesbank policy rate (TR+i_t^∗) led to relatively high real short-term interest rates even during low inflation periods.
  - In the presence of sizable capital flows during the EMS crisis, higher policy rates were required to counterbalance capital outflows; this created a dilemma between hiking interest rates and depleting FX reserves, risking exceeding agreed fluctuation bands (+/-2.25%) under the EMS.

### ERR and alternative anchors
- Where exchange rate pass-through allows influence on inflation via the exchange rate, an ERR (exchange rate rule) is an option.
  - Example: MAS uses an ERR and officially relinquishes control over the level of domestic interest rates; relationship between the interest rate and the exchange rate in Singapore is well-characterized by the UIP condition.
- Countries with capital controls moving toward exchange rate flexibility may specify a UIP+TR rule in their QPMs (quantitative policy models).

### Morocco MQPM example (UIP+TR implementation)
- Policy rule specification:
  - i_t = ω_ip ip_t + (1−ω_ip) iuip_t          (5)
  - ip_t = α_1 ip_{t−1} + (1− α_1)( ip_t + α_2 π_{t+3}^{dev} + α_3 \hat{dd}_t) + ε_{t,ip}        (6)
  - iuip_t = i_t^{ez} + Prem_t + (E_t(MAD/EUR_{t+1}) – MAD/EUR_t )              (7)
- Variable definitions:
  - ip_t is the interbank rate
  - ip_t (second listing) is the natural rate of interest
  - iuip_t UIP-implied interest rate
  - π_{t+3}^{dev} is the t+3 period ahead deviation of the inflation rate from the implicit target
  - \hat{dd}_t is the domestic demand gap
  - i_t^{ez} is the foreign interest rate
  - Prem_t is the country risk premium
  - MAD/EUR is the dirham-to-euro nominal exchange rate
  - ω_ip is the weight assigned to ip_t
- Source notes in MQPM: Benlamine, Laxton, and others (2018).

### Monetary policy rules, exchange rate arrangements, and capital account openness (Figure 8 reference)
- Categories shown include:
  - Monetary Policy Rule: UIP, TR, ERR, TR+UIP, TR + i_t^∗
  - Dimensions: Capital account openness; Exchange rate flexibility
- (Figure source: the authors)

### Liquidity management under an exchange rate anchor
- Introduction of an interest rate corridor system:
  - A corridor system is not incompatible with a fixed exchange rate regime.
  - Morocco introduced an interest rate mid-corridor system under a peg to a currency basket and maintains selected capital controls.
  - Dichotomy principle (Bindseil (2016)): separation between macroeconomic analysis for setting the policy rate and the operational process for stabilizing a short-term money market rate.
- Preconditions for successful mid-corridor under exchange rate anchor:
  - (1) an adequate liquidity forecasting framework;
  - (2) an active interbank market;
  - (3) clear separation between the monetary policy operational framework and emergency liquidity assistance (ELA) framework;
  - (4) relatively developed fixed income markets providing sufficient eligible collateral and longer-term funding instruments; and
  - (5) absence of high levels of speculation against the local currency.
- Timing considerations:
  - Introducing a corridor is more feasible during FX reserve accumulation or when transitioning from liquidity surplus to deficit.
  - In times of unsustainable depreciation expectations and rapidly decreasing net foreign assets (NFA), introducing corridors may be difficult.

### Corridor versus floor systems under a fixed or managed exchange rate
- Drawbacks of a floor system under a fixed exchange rate:
  - Draining surplus liquidity mainly overnight at the initiative of banks can be almost equivalent to leaving free reserves, exerting pressure on international reserves and the peg.
  - Draining surplus liquidity structurally or on longer maturities is important under fixed exchange rate arrangements.
- Mid-corridor operational features:
  - Unique overnight standing lending facility (ceiling) and overnight standing deposit facility (floor) to contain money market rate fluctuations.
  - Standard OMOs could be set at longer maturities (for example, one week) to foster market development when markets are shallow.
  - Full-allotment in liquidity-providing OMOs may lead to over-injection of liquidity that increases demand for FX at the central bank, pressuring FX reserves.

### Tiering floor system under an exchange rate anchor (examples and practices)
- Tiering applies different interest rates to counterparties’ reserves to limit demand for reserves and support money market functioning.
  - Examples: Central Bank of Norway (since 2011), Swiss National Bank, Bank of Japan, ECB.
- Under a floor system with tiering, objectives include avoiding build-up of large freely available deposits that may be used for speculation while ensuring day-to-day liquidity management.
- Danmarks Nationalbank (DNB) practices:
  - Current-account limits: each counterparty awarded a limit equal to 3 percent of its deposits up to DKK 2 billion and 1.7 percent on deposits above 2 billion; mortgage credit institutions have a current account limit of DKK 500 million.
  - Present usage: counterparties currently using their current account fully, reflecting rate differences of the current account (0 percent) and DNB CDs (currently -0.60 percent).
  - DNB standard OMOs include:
    - (1) weekly OMOs: monetary policy loans against collateral (at the lending rate);
    - (2) daily OMOs: offers to buy or sell CDs maturing on the last banking day of the week, with a premium added to the CDs’ interest rate when calculating the CDs’ price to incentivize interbank exchange of liquidity;
    - (3) liquidity adjusting operations: deposits, lending against collateral, FX swaps, via auction or bilateral transactions.
  - DNB does not contain a marginal lending facility; money market rates are not capped and can rise freely in case of exchange rate pressures and capital outflows, with the assumption that rising rates dampen FX outflows and support the fixed exchange rate.
  - From mid-2009 to early 2020, net liquidity position of counterparties has been significantly positive; three-year monetary policy loans were introduced in early 2012 to increase long-term funding availability.

### Transitioning the exchange rate arrangement
- Sustainability conditions for exchange rate anchoring:
  - Adequate international reserves and sometimes an increasing NFA path and preferably a stream of current account surpluses.
  - When NFA are depleted or persistently decreasing, regimes become prone to speculation and unsustainable.
- Paths to greater flexibility:
  - Moving from exchange rate-based to interest rate-based policy often requires transitioning through multiple exchange rate arrangements and demands central bank independence, coordination with Ministry of Finance, and institutional capacity building.
  - Country experiences vary: gradual transitions (Chile, Israel, Poland) and rapid/disorderly ones due to pressure (Brazil, Czech Republic, Uruguay).
  - Transitional arrangements can include: peg to a single currency → peg to a basket → more dynamic basket management (BBC), crawling arrangements, or gradual widening of bands.
- Monetary policy rule adjustments during transition:
  - If interest rate pass-through to inflation is evident, interest rate can be linked to an inflation target enabling a TR or combination of TR and UIP.
  - If interest rate pass-through is absent or very weak and lengthy, the central bank monetary policy rule may take the form of an ERR.

### Key conclusions and policy implications
- Conceptual distinctions:
  - An exchange rate-based monetary policy differs from an interest rate-based monetary policy with FX interventions: under the former the exchange rate is the nominal anchor and main instrument for stabilizing inflation.
- Coherence required:
  - Short-term interest rate and exchange rate are tied by interest rate parity and should be managed coherently to achieve price stability.
- Role of policy rate:
  - The policy rate can have objectives other than smoothing the business cycle; monetary policy rules under exchange rate anchors can differ from standard forward-looking Taylor-type rules.
- Liquidity management importance:
  - Liquidity management should stabilize money market rates and anchor market expectations, curtail surpluses, and limit over-injection of central bank liquidity that pressures international reserves and the exchange rate.
- Institutional and fiscal discipline:
  - Exchange rate anchors are more prone to policy inconsistencies; they require fiscal and monetary discipline and are hardly compatible with fiscal dominance.
- Transition strategy:
  - An exchange rate anchor becomes unsustainable when international reserves are depleted; moving to an interest rate-based policy is often gradual and may be supported by adopting an interest rate corridor, introduced gradually with a steady narrowing of corridor width.
- Operational choices under different pressures:
  - Corridor systems are easier to introduce under partial capital controls or when not subject to highly speculative pressures; tiering floor systems may be envisaged when facing sizeable capital flows.

*Source: IMF working paper — wpiea2020180-print-pdf (content unit: section 4 and surrounding sections as provided).*

### Appendix I. Overview of Countries Adopting an Exchange Rate Anchor

### Appendix I. Overview of Countries Adopting an Exchange Rate Anchor

### Composition of countries with an exchange rate anchor
- "Countries with an exchange rate anchor 28 are a disparate group of 81 high-, middle-, and low-income countries."
- Largest shares by region: Sub-Saharan Africa (SSA) countries, Middle East and Central Asia (MCD) countries, and islands.
- Exchange rate targeters include two monetary unions: CEMAC (Communauté Économique et Monétaire de l’Afrique Centrale) and WAEMU (West African Economic and Monetary Union).
- The ECCU (East Caribbean Currency Union) countries opted for a currency board.
- AREAER 2018 classification figures (preserved exactly):
  - Exchange rate anchor, 81, 42%
  - Monetary aggregate target, 24, 13%
  - Inflation targeting framework, 41, 21%
  - Other, 46, 24%
  - No separate legal tender, 13, 16%
  - Currency board, 11, 13%
  - Conventional peg, 41, 51%
  - Stabilized arrangement, 8, 10%
  - Crawling peg, 3, 4%
  - Crawl-like arrangement, 1, 1%
  - Other managed arrangement, 4, 5%

### Classification of soft pegs (four arrangements) and counts
- Conventional pegs:
  - Largest share pegged to the euro: 18 countries
  - Pegs to the US dollar: 14 countries
  - Five pegs to other currencies (Bhutan, Eswatini, Lesotho, Namibia, and Nepal)
  - Four countries pegged against a basket of foreign currencies: Fiji, Kuwait, Libya, and Morocco
- Stabilized arrangements:
  - Include 8 countries
  - Four stabilize against the USD dollar: Guyana, Lebanon, Maldives, and Trinidad and Tobago
  - Croatia and North Macedonia stabilize against the euro
  - Singapore and Vietnam stabilize against a composite of foreign currencies
- Crawling pegs:
  - Include Botswana, Honduras, and Nicaragua (3)
- Crawl-like arrangement:
  - Adopted by Iran only (1)
- AREAER 2018 notes: "no country has an exchange rate pegged within horizontal bands"

### Appendix I / II: Country group lists and exchange rate anchor counts
- Appendix I. Table 1 groups (preserving group headings and country examples as in the source):
  - SSA countries (19) — includes CEMAC and WAEMU membership lists and OTHER: Botswana, Eritrea, Eswatini, Lesotho, Namibia
  - MCD countries (13) — includes CCA, GCC, NORTH AFRICA, OTHER: Turkmenistan, Bahrain, Kuwait, Oman, Qatar, United Arab Emirates, Saudi Arabia, Libya, Morocco, Iran, Iraq, Jordan, Lebanon
  - Islands (10) — Aruba, The Bahamas, Barbados, Cabo Verde, Comoros, Curaçao and Sint Maarten, Maldives, Fiji, São Tomé and Príncipe, Trinidad and Tobago
  - Advanced economies (2) — Denmark, Singapore
  - Other countries (9) — AMERICAS: Belize, Guyana, Honduras, Nicaragua; ASIA: Bhutan, Nepal, Vietnam; EUROPE: Croatia, North Macedonia
- Appendix II summary (preserving category counts and anchors):
  - Exchange Rate Arrangement (number of countries) — Exchange Rate Anchor (57) broken down by anchor currency:
    - US Dollar (20)
    - Euro (20)
    - Composite (8)
    - Other (5)
  - Conventional peg (41) — country list includes Aruba, The Bahamas, Bahrain, Barbados, Belize, Curaçao and Sint Maarten, Eritrea, Iraq, Jordan, Oman, Qatar, Saudi Arabia, Turkmenistan, United Arab Emirates, Cabo Verde, Comoros, Denmark, São Tomé and Príncipe, WAEMU members (Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, Togo), CEMAC members (Cameroon, Central African Rep., Chad, Rep. of Congo, Equatorial Guinea, Gabon), Fiji, Kuwait, Libya, Morocco, Bhutan, Eswatini, Lesotho, Namibia, Nepal
  - Stabilized arrangements (8) — Guyana, Lebanon, Maldives, Trinidad and Tobago, Croatia, North Macedonia, Singapore, Vietnam
  - Crawling peg (3) — Honduras, Nicaragua, Botswana
  - Crawl-like arrangement (1) — Iran
  - Pegged exchange rate within horizontal bands — (none listed)

### Case study: Czech National Bank (Appendix III) — exchange rate commitment
- Timeline and policy actions:
  - November 7, 2013: CNB decided to use the exchange rate as an additional monetary policy instrument and announced a floor of 27 koruna to the euro after the lower bound on interest rates was reached.
  - Key inflation target: 2 percent.
  - CNB lowered interest rates to 0.05 percent in late 2012 and committed to maintain that record-low level as long as necessary.
  - CNB ended the exchange rate commitment in April 2017.
  - After exit, FX reserves stock reached 70% of GDP.
  - CNB started to raise interest rates gradually in August 2017.
- Objectives and outcomes:
  - Objective of FX interventions to weaken the koruna: prevent deflation and ensure fulfillment of the 2 percent inflation target.
  - The exchange rate commitment mitigated disinflationary shock and supported the CNB’s secondary objective to support general economic policies by helping overcome a recession.
  - Czech economy outcomes:
    - Recession during 2012–13 with rising unemployment, falling consumption, and decreasing corporate profits and investment.
    - Economic growth of 2 percent in 2014, supported by recovering external demand and higher government investment.
  - Inflation dynamics:
    - Slight overshooting of the inflation target in 2017, with inflation moving in the upper half of the tolerance band.
    - Inflation remained above the 2 percent target in 2017 but returned to the target in late 2018 due to stabilizing monetary policy and the appreciating koruna.
- Policy lessons and literature:
  - Caselli (2017): exchange rate commitment effective in mitigating disinflationary effects.
  - Shabunina (2017): analysis suggests a monetary policy response that is ex post too loose is likely to be less costly than one that is ex post too tight, implying a gradual approach to interest rate increases could be preferable.

### Reserves determinants and interactions (Appendix IV)
- Main supply and demand factors of central banks’ foreign reserves (elements preserved as labeled in source figure):
  - Supply / inflow factors: Remittances; Exports/Imports; Capital flows; MoF operations (Treasury account at the CB); CB FX interventions; Aggregate demand of major trade partners; Monetary and FX policies of the anchor country
  - Demand / outflow factors: Banking system liquidity; Currency in Circulation; Domestic FX policy; Domestic Fiscal policy; Domestic Consumption; CB liquidity management; Commercial banks net FX position; Net Demand for CB FX reserves

### Inflation comparisons for peggers / stabilizers (Appendix V)
- Appendix V presents inflation series comparisons (source: IMF WEO) for groups of countries pegging or stabilizing their exchange rate:
  - V.1.1 GCC Countries and US Inflation
  - V.1.2 WAEMU countries and Euro Area Inflation
  - V.1.3 CEMAC countries and Euro Area Inflation
  - V.1.4 Bhutan, Nepal, and India Inflation

*Source: Appendix I. Overview of Countries Adopting an Exchange Rate Anchor; Appendix II; Appendix III; Appendix IV; Appendix V (excerpts) — AREAER 2018 and IMF document content as presented in the supplied PDF content.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2020/english/wpiea2020180-print-pdf.pdf_