External Shocks, Policies, and Tail-Shifts in Real Exchange Rates
IMF Working Papers, June 23, 2023
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- External Shocks, Policies, and Tail-Shifts in Real Exchange Rates
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Bibliographic details
- Authors: Nicolas E Magud, Samuel Pienknagura
- Published: June 23, 2023
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9798400247019.001
Methods
- Approach: Panel quantile regressions to study extreme (rather than average) movements in the distribution of the real effective exchange rate (REER) of small open economies.
- Key shocks analyzed: global uncertainty (VIX) and global financial conditions (U.S. monetary policy).
Core findings
- Global uncertainty (VIX) and U.S. monetary policy shocks:
- Have a strong impact on the distribution of REER changes.
- Produce larger impacts in the tails of the REER distribution.
- Heterogeneous amplification:
- Larger tail impacts in economies with shallower FX markets.
- Larger tail impacts in economies with lower central bank credibility.
- Larger tail impacts in economies with higher credit risk (weaker macro fundamentals).
- Foreign exchange intervention (FXI):
- Partially offsets the impact of global shocks.
- Particularly effective in the left tail (large depreciations).
- More effective in economies with weaker fundamentals.
- More effective when FXI is used sporadically.
- Capital flow management:
- Low effectiveness in preventing large REER movements.
- May enable more impactful FXI in the immediate aftermath of shocks.
Policy implications and recommendations
- Strengthen market and institutional fundamentals to reduce extreme REER moves:
- Deepen FX markets.
- Improve central bank credibility.
- Strengthen macro fundamentals (reduce credit risk).
- Use FXI with caution:
- FXI can mitigate large depreciations, especially when used sporadically and in economies with weaker fundamentals.
- Overreliance on FXI risks dynamic trade-offs and may exacerbate underlying frictions.
- Calibrate capital flow management recognizing its limited role in preventing large REER swings but potential to support FXI effectiveness immediately after shocks.
Keywords and subject focus
- Subject: Currency markets; Depreciation; Financial markets; Foreign exchange; Foreign exchange intervention; National accounts; Real effective exchange rates; Real exchange rates.
- Keywords: capital controls; central bank credibility; Currency markets; Depreciation; external shocks; foreign exchange intervention; FXI effectiveness; Global; IMF working paper 23/129; Real effective exchange rates; Real exchange rates; REER distribution; VIX shock.
Source: IMF Working Papers — "External Shocks, Policies, and Tail-Shifts in Real Exchange Rates" by Nicolas E Magud and Samuel Pienknagura (June 23, 2023).
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