## Foreign Exchange Intervention under Policy Uncertainty

_IMF Working Papers, March 17, 2016_

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## Bibliographic details
- Authors: Gustavo Adler, Ruy Lama, Juan Pablo Medina Guzman
- Published: March 17, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475520415.001

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### Research question and setup
- Study focus: use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions.
- Key modeling distinction:
  - Full information regime: agents know central bank objectives and reaction functions.
  - Policy uncertainty regime: agents perceive that monetary policy may also have exchange rate stabilization goals and learn the policy from observed actions.

### Main findings
- Under full information:
  - A central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool.
- Under policy uncertainty:
  - Use of FX intervention entails a trade-off: reducing output volatility while increasing inflation volatility.
- Optimal magnitude of intervention:
  - Having an additional policy tool is always beneficial.
  - The optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty.
- Interpretation:
  - Benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.

### Policy implications
- FX intervention can complement monetary policy to improve stabilization, but its net effect depends on the credibility and transparency of monetary policy.
- In regimes with lower policy uncertainty (higher credibility), authorities can optimally employ larger FX intervention to improve outcomes.
- In regimes with higher policy uncertainty, authorities face a trade-off and should weigh reductions in output volatility against potential increases in inflation volatility when designing intervention strategies.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/foreign-exchange-intervention-under-policy-uncertainty-43801_