Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework
IMF Working Papers, January 14, 2013
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- Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework
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Bibliographic details
- Authors: Jaromir Benes, Andrew Berg, Rafael A Portillo, David Vávra
- Published: January 14, 2013
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475545401.001
Summary and main findings
- The paper studies a wide range of hybrid inflation-targeting (IT) and managed exchange rate regimes and analyzes implications for inflation, output, and the exchange rate under various domestic and external shocks.
- The authors develop an open economy new-Keynesian model that features sterilized interventions in the foreign exchange (FX) market as an additional central bank instrument operating alongside the Taylor rule.
- Sterilized FX interventions affect the economy through portfolio balance sheet effects in the financial sector.
- Key empirical conclusion: there can be advantages to combining IT with some degree of exchange rate management via FX interventions.
- Comparative insights:
- Unlike "pure" IT or exchange rate management via interest rates, FX interventions can help insulate the economy against certain shocks, especially shocks to international financial conditions.
- FX interventions may hinder necessary exchange rate adjustments in some scenarios, for example, in the presence of terms of trade shocks.
Model structure and instruments
- Framework: open economy new-Keynesian model.
- Central bank instruments included:
- Taylor rule (interest rate instrument).
- Sterilized FX interventions (affecting portfolio balance sheet effects in the financial sector).
- Channels emphasized:
- Interest rate channel (standard in Taylor-rule frameworks).
- Balance sheet / portfolio channel through FX intervention and sterilization operations.
Policy implications and trade-offs
- Combining inflation targeting with managed exchange rate elements can provide insurance against certain external shocks, particularly shocks to international financial conditions.
- Trade-off: interventions that stabilize the exchange rate can reduce exchange rate volatility but may prevent needed adjustments (e.g., after terms of trade shocks), potentially amplifying real imbalances.
- Policy design considerations:
- The efficacy of sterilized FX interventions depends on the nature of shocks (financial vs. terms of trade).
- Optimal policy may involve calibrated use of FX interventions alongside interest rate policy rather than exclusive reliance on either instrument.
Keywords and subject coverage
- Subject areas: Banking, Central bank policy rate, Exchange rate arrangements, Exchange rates, Financial services, Foreign exchange, Real exchange rates.
- Keywords: Central bank policy rate, corridor simulation, Eastern Europe, emerging markets, Exchange rate arrangements, exchange rate corridor, exchange rate depreciation, exchange rate intervention, exchange rate market, exchange rate movement, exchange rate targeting, exchange rate volatility, Exchange rates, Global, interest rate instrument, interest rate premium, interest rate rule, interest rate shock, managed float, monetary policy, new-Keynesian economics, Real exchange rates, Sterilized FX interventions, WP.