FX Intervention in the New Keynesian Model
IMF Working Papers, September 29, 2017
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- FX Intervention in the New Keynesian Model
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Bibliographic details
- Authors: Zineddine Alla, Raphael A Espinoza, Atish R. Ghosh
- Published: September 29, 2017
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484320617.001
Document
- Authors: Zineddine Alla, Raphael A Espinoza, Atish R. Ghosh
- Publication type: IMF Working Papers
- Date: September 29, 2017
Model and methodology
- Develops an open economy New Keynesian Model with foreign exchange (FX) intervention in the presence of a financial accelerator mechanism.
- Obtains closed-form solutions for:
- the optimal interest rate policy, and
- FX intervention under discretionary policy,
in the face of shocks to risk appetite in international capital markets.
Main findings
- FX intervention can help reduce the volatility of the economy.
- FX intervention can mitigate the welfare losses associated with shocks to risk appetite in international capital markets.
- When the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high.
- The authors determine the conditions under which indeterminacy can occur.
Policy implications and recommendations
- Use of FX intervention can reinforce the central bank’s credibility.
- FX intervention can limit the risk of multiple equilibria, thereby reducing the likelihood of self-fulfilling speculative attacks and volatile currency and inflation dynamics.
- Optimal policy design should account for interactions between financial accelerator effects and international risk-premium shocks when choosing the combination of interest rate policy and FX intervention.
Key concepts and topics covered
- Consumption
- Exchange rates
- Foreign exchange
- Inflation
- National accounts
- Prices
- Return on investment
- Capital controls, Capital flows
- Central bank, Central bank reserves
- Equilibrium determinacy
- FX intervention, sterilized foreign exchange intervention
- Open Economy New Keynesian Model
- Portfolio balance model
- Risk premium, risk premium shock
- Speculative attack
- Terms of trade, working capital
Source: IMF Working Paper "FX Intervention in the New Keynesian Model" by Zineddine Alla, Raphael A Espinoza, and Atish R. Ghosh, September 29, 2017.
Content in this bundle
- FX Intervention in the New Keynesian Model, WP/17/207, September 2017