## _sdn1201 - Executive Summary

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---

### Executive overview
- Purpose: Examine using two policy instruments—the policy interest rate and sterilized foreign exchange (FX) market intervention—in emerging market economies (EMEs) that aim to maintain low inflation while avoiding exchange rate movements that clearly represent substantial deviations from medium-run multilaterally-consistent values.
- Central contention: Paying attention to the exchange rate need not undermine inflation-targeting (IT) credibility. In EMEs with currency mismatches, high pass-through, and limited factor mobility, ignoring exchange rate volatility can be costly; sterilized intervention together with interest rate policy can improve outcomes.
- Normative signal: Monetary authorities should signal that the policy interest rate safeguards the primacy of the inflation target, while sterilized FX intervention is deployed to resist exchange rate deviations from medium-run warranted value.

### Analytical framework and assumptions
- Two core assumptions:
  - Large deviations of the real exchange rate from its multilaterally-warranted value are costly.
  - Imperfect capital mobility/asset substitutability exists, so central banks have two instruments: the policy interest rate and sterilized FX intervention.
- Policy question: How should the central bank use these two instruments to achieve two targets (inflation and exchange-rate proximity to medium-run fundamentals)?
- Regime distinction:
  - Discretion: inflationary bias via public perception of central bank incentives.
  - IT (lexicographic): inflation target is always met (no inflationary bias).

### Practical motivation for two instruments in EMEs
- Structural features making exchange-rate responses material:
  - Significant currency mismatches on domestic balance sheets.
  - Higher pass-through of exchange rate to inflation.
  - Less developed domestic financial markets and smaller stocks of outstanding local-currency assets (increasing scope for sterilized intervention).
  - Greater proneness to sudden stops and imperfect integration with global financial markets.

### Empirical evidence — interest rate reaction functions (Taylor-type rules)
- Panel regression for 14 EME IT countries (summary statistics reproduced exactly as reported):
  - Lagged (policy rate - inflation target): 0.744 ***
  - Expected inflation - inflation target: 1.353 *** (Column 1); 0.649 *** (Column 2); 0.699 *** (Column 3)
  - REER deviation from trend (log real effective exchange rate deviation): -0.029 *** (Column 3)
  - Lagged output gap coefficient: 0.064 * (Column 3)
  - Dummy for global financial crisis: -0.271 (Column 1); -0.801 *** (Column 2); -0.840 *** (Column 3)
  - Observations: 522 (Col 1), 516 (Col 2), 470 (Col 3)
  - R-squared: 0.334 (Col 1), 0.821 (Col 2), 0.812 (Col 3)
  - Number of countries: 14
- Interpretation:
  - EME IT central banks follow the “Taylor principle,” raising real rates when expected inflation or output exceed targets.
  - They respond to real exchange rate movements beyond pass-through to inflation: a 10 percent appreciation is associated with a 0.29 percentage point lowering of the policy interest rate (point estimate reported).

### Empirical evidence — FX intervention behavior
- Intervention intensity statistic (standard deviation-based): inflation-targeting EMEs = 0.63; non-IT EMEs = 0.73 (statistic ranges from 0 for pure float to 1 for perfect smoothing).
- Regression of change in reserves on REER deviation from trend (Table 2 — exact reported coefficients):
  - IT sample: REER deviation coefficient = 0.380 ** ; Dummy for global financial crisis = -8.795 * ; Constant = 10.769 ***
  - Non-IT sample: REER deviation coefficient = 1.405 *** ; Dummy for global financial crisis = -23.495 *** ; Constant = 15.349 ***
  - Observations: 452 (IT), 399 (Non-IT)
  - R-squared: 0.087 (IT), 0.327 (Non-IT)
  - Number of countries: 14 (IT), 10 (Non-IT)
- Interpretation:
  - IT EMEs do intervene actively in FX markets, though generally less aggressively than non-IT EMEs.
  - A 10 percent appreciation is associated with a 3.8 percent increase in reserves in the IT sample (point estimate noted, with simultaneity bias implying it may be an underestimate); for the non-IT sample the comparable point estimate is 14.1 percent.

### Effectiveness of sterilized intervention in EMEs
- Two transmission channels:
  - Portfolio-balance channel: changes in relative supply of domestic vs. foreign assets matter under imperfect substitutability; stronger in EMEs with smaller local bond markets.
  - Signaling channel: intervention reveals central bank information about fundamentals or future policy stance.
- Empirical survey (Table 3): studies across EMEs show mixed but generally positive evidence; many studies find intervention affects volatility more reliably than level.
  - Examples summarized from survey (exact study attributions preserved in source): Brazil — Yes on level and volatility; Chile — Yes on level; Colombia — Yes (mixed/weak).
- Circumstance dependence:
  - Effectiveness varies with macro context and openness of capital account; interventions less effective with more open capital accounts and more effective when exchange rates are ‘overvalued.’
- Conclusion:
  - Evidence on sterilized intervention in EMEs is mixed but generally more favorable than in advanced-economy contexts.
  - Given prevalence of sterilized intervention by EME central banks, treating central banks as having two instruments is plausible.

### Model results — IT with and without sterilized FX intervention (summary of Box 1 and main text)
- Model setup:
  - Small open EME with imperfect capital mobility; central bank minimizes deviations of inflation from target, output gap from potential, exchange rate from medium-term fundamentals, and excess reserve accumulation costs.
- Key quantitative/numeric inputs and experiment notes:
  - Demand shock simulation: 2.5 percentage point increase in domestic demand.
  - Capital inflow shock simulation: 5 percentage point decline in the world interest rate.
  - Footnote empirical example: Expected return over periods 1–10 averages 2.1 percent under IT with FX intervention, and 1.8 percent under IT without intervention.
- Main model insights (exact qualitative findings preserved):
  - Policy assignment under IT + sterilized intervention:
    - Use policy interest rate to meet the inflation target.
    - Use sterilized FX intervention to limit exchange rate deviations from medium-run warranted value.
  - Shock responses:
    - Positive aggregate demand shock: with intervention, central bank raises interest rates more and uses two-way intervention (initial reserve increase, later decline); without intervention the central bank raises rates less and tolerates a more appreciated currency.
    - Capital inflow shock: central bank lowers policy rate less when it can intervene; without intervention it must lower rates more and accept a more appreciated exchange rate; intervention path is two-way (initial purchases then sales) with no net steady-state reserve change.
  - Welfare implications:
    - IT combined with sterilized intervention dominates IT without intervention because it keeps the exchange rate closer to fundamentals without compromising inflation targeting.
    - The welfare gain from adding the FX instrument depends on capital flow characteristics: interest rate sensitivity of capital flows (γ_r) and persistence of inflows (ρ r*) are key determinants.
  - Discretion vs. IT:
    - Fully discretionary policy yields small additional welfare gains relative to IT in the presence of divine coincidence; when credibility is fragile, discretionary gains may be negative. The main welfare improvement comes from having a second instrument (sterilized intervention).

### Box 1 — Model specification, calibration, and simulation sensitivities (exact elements reproduced)
- Model specification highlights (variables and equations described in source; UIP not assumed).
- Calibration reproduced exactly as in source:
  - * 0.15;1;0.5;1;0.5;0.99;0.75 0.3;1;0.25;0.75 1;0.1;0.01 rk r yre u ab c ε φ γ γ α σ β ρ φ ψ ψ ρ      
- Sensitivity findings (preserved verbatim):
  - As γ r increases, sterilized FX intervention becomes less effective; in the limit γ r → ∞ (perfect capital mobility), sterilized intervention becomes impossible.
  - Reserve accumulation is non-monotonic in γ r.
  - Degree of intervention (as a percentage of initial inflows) is monotonically decreasing in expected persistence of inflows.
  - Responses to outflow shocks are mirror images of those to inflow shocks.
  - Optimal intervention usually allows a jump in real appreciation followed by gradual depreciation; some uncertainty/randomization in intervention policy can discourage one-way bets but has welfare costs.
  - Example trade-off: adding a normally distributed shock to optimal reserve policy with standard deviation of 2.5 percent yields a resulting distribution of expected returns with standard deviation of 1.4 percent; adverse welfare effect equates to capital inflows resulting from a further 125 basis point decrease in the world interest rate.

### Policy implications and recommendations (operational and multilateral)
- Operational guidance:
  - Signal that the policy interest rate is primarily for preserving inflation-targeting credibility.
  - Use sterilized FX intervention only to counter shocks that move the exchange rate away from its medium-run multilaterally-consistent value.
  - Ensure intervention is two-way (both purchases and sales of reserves over time) rather than permanent one-way accumulation or depletion.
  - Limit intervention to episodes where exchange rate deviates clearly from medium-term fundamentals; frequent or large-scale intervention is costly and may be ineffective if inflows are persistent or intervention effectiveness is weak.
- Prudential considerations:
  - Sterilized intervention is not costless; central banks should weigh effectiveness, persistence of inflows, and reserve-holding costs.
  - Intervention can reduce incentives for carry trades and short-term flows when inflows are driven by self-fulfilling expectations of appreciation.
  - Complementary measures (macroprudential policies, temporary capital controls) are part of the broader toolkit but are not modeled here; intervention might diminish the need for temporary capital controls in some circumstances.
- Multilateral perspective:
  - An IT regime combined with FX intervention likely brings global exchange rates closer to their multilaterally-warranted ranges than either unconstrained unilateral discretion or a narrow IT regime that eschews intervention.
  - Cooperative policies involving FX intervention across recipient countries would likely improve global exchange-rate configurations relative to a non-cooperative Nash outcome.

*Source: _sdn1201 - Executive Summary (IMF PDF).*

### Executive Summary ......................................................................................................

### _sdn1201 - Executive Summary

### I. Introduction
- Section present on page 4.

### II. Two Targets, Two Instruments
- Section present on page 5.

### III. Policies of EME Central Banks
- Section present on page 7.

### IV. Effectiveness of Foreign Exchange Intervention in EMEs
- Section present on page 10.

### V. Inflation Targeting and Foreign Exchange Intervention
- Section present on page 13.

### VI. Multilateral Considerations
- Section present on page 20.

### VII. Conclusions
- Section present on page 21.

### Figures
- Figure 1. Policy Response to a Demand Shock (page 16).
- Figure 2. Policy Response to a Capital Inflow Shock (page 17).

### Tables
- Table 1. Taylor Rules in Emerging Market Inflation Targeters: Panel Regression (page 9).
- Table 2. Change in Reserves as a Function of the Change in the REER (page 10).
- Table 3. Studies on Sterilized Intervention in Emerging Market Economies (page 12).

### Box
- Box 1. A Simple Dynamic Model of an Emerging Market Economy (page 15).

### Other
- References (page 23).
- Online Appendix (location indicated).

*Source: _sdn1201 - Executive Summary (IMF PDF); provided page and section listings as supplied.*

### Executive Summary

### _sdn1201 - Executive Summary

### Executive overview
- Purpose: Examine using two policy instruments—the policy interest rate and sterilized foreign exchange (FX) market intervention—in emerging market economies (EMEs) that aim to maintain low inflation while avoiding exchange rate movements that clearly represent substantial deviations from medium-run multilaterally-consistent values.
- Central contention: Paying attention to the exchange rate need not undermine inflation-targeting (IT) credibility. In EMEs with currency mismatches, high pass-through, and limited factor mobility, ignoring exchange rate volatility can be costly; sterilized intervention together with interest rate policy can improve outcomes.

### Analytical framework and assumptions
- Two core assumptions:
  - Large deviations of the real exchange rate from its multilaterally-warranted value are costly (examples: dynamic Dutch disease, balance sheet effects), so central banks should care about the exchange rate in addition to inflation.
  - Imperfect capital mobility/asset substitutability exists, so central banks have two instruments: the policy interest rate and FX market intervention (sterilized).
- Policy question: How should the central bank use these two instruments to achieve two targets (inflation and exchange-rate proximity to medium-run fundamentals)?
- Normative signal: Monetary authorities should signal that the policy interest rate safeguards the primacy of the inflation target, while sterilized FX intervention is deployed to resist exchange rate deviations from medium-run warranted value.

### Practical motivation for two instruments in EMEs
- Structural features making exchange-rate responses material in EMEs:
  - Significant currency mismatches on domestic balance sheets.
  - Higher pass-through of exchange rate to inflation.
  - Less developed domestic financial markets and smaller stocks of outstanding local-currency assets, increasing scope for sterilized intervention.
  - Greater proneness to sudden stops and imperfect integration with global financial markets.

### Empirical evidence: interest rate reaction functions (Taylor-type rules)
- Panel regression results for 14 EME IT countries show:
  - Lagged (policy rate - inflation target): 0.744 ***
  - Expected inflation - inflation target: 1.353 *** (Column 1) ; 0.649 *** (Column 2) ; 0.699 *** (Column 3)
  - REER deviation from trend (log real effective exchange rate deviation): -0.029 *** (Column 3)
  - Lagged output gap coefficient: 0.064 * (Column 3)
  - Dummy for global financial crisis: -0.271 (Column 1); -0.801 *** (Column 2); -0.840 *** (Column 3)
  - Observations: 522 (Col 1), 516 (Col 2), 470 (Col 3)
  - R-squared: 0.334 (Col 1), 0.821 (Col 2), 0.812 (Col 3)
  - Number of countries: 14
- Interpretation:
  - EME inflation-targeting central banks follow the “Taylor principle,” raising real rates when expected inflation or output exceed targets.
  - They respond to real exchange rate movements beyond pass-through to inflation: a 10 percent appreciation of the currency lowers the policy interest rate by 0.29 percentage points (point estimate reported).

### Empirical evidence: FX intervention behavior
- Intervention intensity statistic (standard deviation-based): inflation-targeting EMEs = 0.63; non-IT EMEs = 0.73 (statistic ranges from 0 for pure float to 1 for perfect smoothing).
- Regression of change in reserves on REER deviation from trend (Table 2):
  - IT sample: REER deviation coefficient = 0.380 ** ; Dummy for global financial crisis = -8.795 * ; Constant = 10.769 ***
  - Non-IT sample: REER deviation coefficient = 1.405 *** ; Dummy for global financial crisis = -23.495 *** ; Constant = 15.349 ***
  - Observations: 452 (IT), 399 (Non-IT)
  - R-squared: 0.087 (IT), 0.327 (Non-IT)
  - Number of countries: 14 (IT), 10 (Non-IT)
- Interpretation:
  - Inflation-targeting EMEs do intervene actively in FX markets, though generally less aggressively than non-IT EMEs.
  - A 10 percent appreciation is associated with a 3.8 percent increase in reserves in the IT sample (point estimate noted, with simultaneity bias implying it may be an underestimate); for the non-IT sample the comparable point estimate is 14.1 percent.

### Effectiveness of sterilized intervention in EMEs
- Two channels for sterilized intervention:
  - Portfolio-balance channel: changes relative supply of domestic vs. foreign assets matter under imperfect substitutability; stronger in EMEs where local bond markets are smaller.
  - Signaling channel: intervention reveals central bank information about fundamentals or future policy stance.
- Empirical survey (Table 3) — studies across EMEs show mixed but generally positive evidence:
  - Examples: Brazil (Stone, Walker, and Yosuke (2009)) — Yes on level and volatility; Chile (Tapia and Tokman (2004)) — Yes on level; Colombia (Mandeng (2003), Kamil (2008)) — Yes (mixed/weak); many studies find intervention affects volatility more reliably than level.
- Circumstance dependence:
  - Effectiveness varies with macro context (e.g., Kamil (2008) finds effectiveness in Colombia during easing but not during tightening).
  - Interventions less effective with more open capital accounts and more effective when exchange rates are ‘overvalued.’
- Conclusion on effectiveness:
  - Evidence on sterilized intervention in EMEs is mixed but generally more favorable than in advanced-economy contexts.
  - Given the prevalence of sterilized intervention by EME central banks, the assumption that central banks have two instruments is plausible.

### Model results: IT with and without sterilized FX intervention
- Setup: small open EME with imperfect capital mobility; central bank minimizes deviations of inflation from target, output gap from potential, and exchange rate from medium-term fundamentals; also minimizes excess reserve accumulation costs.
- Credibility distinction:
  - Discretion: inflationary bias exists via public perception of central bank incentives.
  - IT: lexicographic ordering ensures inflation target is always met (no inflationary bias).
- Key model insights (dynamic model and two-period analytical results available in Online Appendix):
  - Policy assignment under IT + sterilized intervention:
    - Use policy interest rate to meet inflation target.
    - Use sterilized FX intervention to limit exchange rate deviations from medium-run warranted value.
  - Responses to shocks:
    - Positive aggregate demand shock: with intervention, central bank raises interest rates by more and uses two-way intervention (initial reserve increase, later decline), avoiding sustained one-way accumulation; without intervention the central bank raises rates less and tolerates a more appreciated currency.
    - Capital inflow shock: central bank lowers policy rate less when it can intervene; without intervention it must lower rates more and accept a more appreciated exchange rate; intervention path is two-way (initial purchases then sales) with no net steady-state reserve change.
  - Welfare implications:
    - IT combined with sterilized intervention dominates IT without intervention because it keeps the exchange rate closer to fundamentals without compromising inflation targeting.
    - The welfare gain from adding the FX instrument depends on capital flow characteristics: interest rate sensitivity of capital flows (γ_r) and persistence of inflows are key determinants.
  - Discretion vs. IT:
    - Fully discretionary policy yields small additional welfare gains relative to IT in the presence of divine coincidence; when credibility is fragile, discretionary gains may be negative. The main welfare improvement comes from having a second instrument (sterilized intervention).

### Policy implications and recommendations
- Operational guidance:
  - Signal that the policy interest rate is primarily for preserving inflation-targeting credibility.
  - Use sterilized FX intervention only to counter shocks that move the exchange rate away from its medium-run multilaterally-consistent value.
  - Ensure intervention is two-way (both purchases and sales of reserves over time) rather than permanent one-way accumulation or depletion.
  - Limit intervention to episodes where exchange rate deviates clearly from medium-term fundamentals; frequent or large-scale intervention is costly and may be ineffective if inflows are persistent or intervention effectiveness is weak.
- Prudential considerations:
  - Recognize sterilized intervention is not costless; central banks should weigh effectiveness, persistence of inflows, and reserve-holding costs.
  - Intervention can reduce incentives for carry trades and short-term flows when inflows are driven by self-fulfilling expectations of appreciation.
  - Complementary measures (macroprudential policies, temporary capital controls) are part of the broader toolkit but are not modeled here; intervention might diminish the need for temporary capital controls in some circumstances.
- Multilateral perspective:
  - An IT regime combined with FX intervention likely brings global exchange rates closer to their multilaterally-warranted ranges than either unconstrained unilateral discretion or a narrow IT regime that eschews intervention.
  - Such a regime can improve global welfare without requiring costly explicit policy coordination.

*Source: _sdn1201 - Executive Summary (IMF).*

### Box 1. A Simple Dynamic Model of an Emerging Market Economy

### Box 1. A Simple Dynamic Model of an Emerging Market Economy

### Model specification
- Variables are in logs, except ca (current account balance) defined as the current account balance as a ratio to the foreign liability position, k. All parameters (Greek letters) are positive.
- Capital flows: partial adjustment process converging to a finite stock for a given expected return differential:
  - 11 )(  tkt ttt trt keErrk
  - e is the real exchange rate (an increase is an appreciation), r and r* are domestic and foreign real interest rates.
  - Uncovered interest parity (UIP) is assumed not to hold.
- Foreign real interest rate: AR(1) process:
  - **r**t* = ρ r t−1* + ηt
- Current account:
  - ca = φ e t − φ y (y t − y t*)
- Balance of payments (BOP):
  - ΔR t + Δk t = Δca t (where σ = R/k)
- Phillips curve (domestic inflation):
  - π t+1 = β π t + κ E t y t
- Aggregate demand (IS curve):
  - y t = φ e e t − φ r r t + u t, where u t is AR(1) with parameter ρ u.
- Central bank objective function minimizes:
  - min E t [a(y t − y*)^2 + b π t^2 + c(e t − e* )^2 + d(R t − R* )^2]
  - includes the output gap, inflation, deviation of the real exchange rate from its multilaterally-consistent level (normalized to zero), and deviation of reserves from their optimal steady-state level.
  - e t y is the public’s estimate of the central bank’s inflationary bias.

### Calibration
- Calibration line reproduced as in the source:
  - * 0.15;1;0.5;1;0.5;0.99;0.75 0.3;1;0.25;0.75 1;0.1;0.01 rk r yre u ab c ε φ γ γ α σ β ρ φ ψ ψ ρ      
- In discretionary policy regimes, the public sector’s estimate of the inflation bias is calibrated so inflationary expectations equal 0.9 times the previous period’s inflation rate; set equal to zero in IT regimes.

### Simulation scenarios and key numeric experiment notes
- Demand shock simulation:
  - The shock is based on a 2.5 percentage point increase in domestic demand. (Figure notes)
- Capital inflow shock simulation:
  - The capital inflow shock is based on a 5 percentage point decline in the world interest rate. (Figure notes)
- Footnote empirical example:
  - Expected return (inclusive of the interest rate differential and expected depreciation) over periods 1–10 averages 2.1 percent under IT with FX intervention, and 1.8 percent under IT without intervention.

### Main simulation findings
- Sensitivity of inflows to return differential (γ r):
  - As γ r increases, sterilized FX intervention becomes less effective; in the limit γ r → ∞ (perfect capital mobility), sterilized intervention becomes impossible.
  - Greater sensitivity implies the central bank must tolerate a higher real appreciation and undertake less intervention proportional to the capital flow.
  - Reserve accumulation is non-monotonic in γ r: small γ r → small initial reserve change; as γ r increases initially FX intervention increases, then declines as γ r → ∞.
  - The more responsive capital flows are to the return differential, the more the policy rate is lowered (central bank relies more on interest rate changes as capital mobility increases).
- Persistence of inflows (ρ r*):
  - The less persistent the shock to the foreign interest rate, the less persistent the inflows and the smaller the required policy response.
  - Initial intervention (reserve accumulation) as a percentage of the initial capital inflow is greater when inflows are expected to be less persistent.
  - Degree of intervention (as a percentage of initial inflows) is monotonically decreasing in expected persistence of inflows.
  - When shocks are more persistent, policy interest rate will be lowered by more and play a larger role relative to FX intervention.
- Response symmetry:
  - Responses to outflow shocks are mirror images of those to inflow shocks of similar magnitude.
  - In temporary outflows, central bank would raise policy rates to keep output gap at zero, raising rates more aggressively in non-FX intervention regimes.
  - Central bank can run out of reserves but has no obvious limit to accumulation during inflows—thus distinguishing temporary versus persistent outflows is critical.
  - For temporary outflows, on-lending foreign exchange to unhedged borrowers may be preferable to FX market intervention.

### Policy implications within regimes
- Inflation targeting (IT) with FX intervention vs IT without FX intervention:
  - IT without FX intervention tends to lower policy interest rates more than IT with FX intervention.
  - IT-cum-intervention yields outcomes closer to coordinated international policy outcomes (in terms of interest rate policy and intervention) than IT without FX intervention.
  - Regimes with FX intervention generally imply somewhat higher and more persistent expected returns compared to regimes without intervention.
- Optimal intervention behavior:
  - Optimal intervention usually allows a jump in real appreciation followed by gradual depreciation; intervention is chosen to avoid offering investors a sure expected appreciation that would induce larger inflows.
  - Some uncertainty/randomization in intervention policy (timing/amount/level) can discourage one-way bets by investors, but randomization has welfare costs through reserve and exchange rate volatility.
  - Example trade-off: adding a normally distributed shock to optimal reserve policy with standard deviation of 2.5 percent yields a resulting distribution of expected returns with standard deviation of 1.4 percent; adverse welfare effect equates to capital inflows resulting from a further 125 basis point decrease in the world interest rate.
- Multilateral considerations:
  - Uncoordinated discretionary monetary policies across EMEs lead to too low interest rates, too little reserves accumulation, and excessive appreciation of EME currencies.
  - Each central bank, acting non-cooperatively, has incentives to lower interest rates and allow more appreciation to deflect capital inflows to others, yielding an equilibrium with lower policy rates and less sterilized intervention than coordinated policies would imply.
  - IT-cum-intervention regimes bring cross-country exchange rate configurations closer to the multilaterally-consistent global equilibrium than uncoordinated discretionary policies.
  - Coordination between capital-sending and capital-receiving countries can reduce the magnitude of capital inflow shocks; coordination among recipient EMEs can result in superior outcomes.

### Conclusions and recommendations
- Because EMEs often lack full policy credibility, inflation targeting is attractive to anchor expectations and generate low inflation.
- Given EMEs’ structural features and volatile capital flows, benign neglect of large exchange rate movements inconsistent with multilateral medium-run equilibrium is unlikely to be appropriate under IT.
- When two instruments are available (policy interest rate and FX intervention), they should be used in tandem to achieve price stability and exchange-rate objectives.
- A two-instrument IT framework can:
  - Anchor inflationary expectations when credibility is imperfect.
  - Avoid the inflationary bias associated with discretionary policies while addressing exchange-rate deviations from fundamentals.
  - Yield macro stability (low output gap and inflation, stable real exchange rate around fundamentals) provided FX intervention is subordinated to achieving low inflation.
- Intervening to limit appreciation can raise multilateral concerns when push factors drive widespread inflows; nonetheless, cooperative policies involving FX intervention across recipient countries would likely improve global exchange-rate configurations relative to a non-cooperative Nash outcome.
- Practical cautions:
  - Central banks face challenges gauging persistence of capital flows in real time, given dependence on global risk aversion and monetary policy in industrial countries.
  - Central banks should be cautious before using FX intervention in outflow episodes unless outflows are large, abrupt, and threaten severe economic dislocation.

*Source: Box 1. A Simple Dynamic Model of an Emerging Market Economy (excerpt).*

### REFERENCES

### _sdn1201 - REFERENCES

### References

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- Adler, Gustavo, and Camilo E. Tovar, 2011, “Foreign Exchange Intervention: A Shield Against Appreciation Winds?” IMF Working Paper No. 11/165.
- Aizenman, Joshua, Menzie Chinn, and Hiro Ito, 2008, “Assessing the Emerging Global Financial Architecture: Measuring the Trilemma’s Configuration Over Time,” NBER Working Paper No. 14533 (Cambridge, Massachusetts: NBER).
- Aizenman, Joshua, Michael Hutchison, and Ilan Noy, 2011, “Inflation Targeting and Real Exchange Rates in Emerging Markets,” World Development, Vol. 39, No. 5, pp. 712–24.
- Benes, Jaromir, A. Berg, R. Portillo, and D. Vavra, 2012, “Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy,” IMF Working Paper, forthcoming.
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- Ostry, Jonathan, Atish R. Ghosh, Karl Habermeier, Luc Laeven, Marcos Chamon, Mahvash S. Qureshi, and Annamaria Kokenyne, 2011, “Managing Capital Inflows: What Tools To Use?” IMF Staff Discussion Note (Washington: International Monetary Fund).
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- Stone, Mark, W. Christopher Walker, and Yosuke Yasui, 2009, “From Lombard Street to Avenida Paulista: Foreign Exchange Liquidity Easing in Brazil in Response to the Global Shock of 2008–09,” IMF Working Paper 09/259.
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*Source: _sdn1201 - REFERENCES*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/sdn/2012/_sdn1201.pdf_