FX Intervention in the New Keynesian Model
FX Intervention in the New Keynesian Model

Author: Zineddine Alla

Publisher: International Monetary Fund

Published: 2017-09-29

Total Pages: 39

ISBN-13: 1484323831

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We develop an open economy New Keynesian Model with foreign exchange intervention in the presence of a financial accelerator mechanism. We obtain 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. The solution shows that FX intervention can help reduce the volatility of the economy and mitigate the welfare losses associated with such shocks. We also show that, when the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high. We determine the conditions under which indeterminacy can occur and highlight how the use of FX intervention reinforces the central bank’s credibility and limits the risk of multiple equilibria.

Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework
Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework

Author: Mr.Jaromir Benes

Publisher: International Monetary Fund

Published: 2013-01-14

Total Pages: 43

ISBN-13: 1475545401

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We study a wide range of hybrid inflation-targeting (IT) and managed exchange rate regimes, analyzing their implications for inflation, output and the exchange rate in the presence of various domestic and external shocks. To this end, we develop an open economy new-Keynesian model featuring sterilized interventions in the foreign exchange (FX) market as an additional central bank instrument operating alongside the Taylor rule, and affecting the economy through portfolio balance sheet effects in the financial sector. We find that there can be advantages to combining IT with some degree of exchange rate management via FX interventions. 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. However, managing the exchange rate through FX interventions may also hinder necessary exchange rate adjustments, e.g., in the presence of terms of trade shocks.

A Quantitative Model for the Integrated Policy Framework
A Quantitative Model for the Integrated Policy Framework

Author: Mr.Tobias Adrian

Publisher: International Monetary Fund

Published: 2020-07-07

Total Pages: 56

ISBN-13: 1513549669

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Many central banks have relied on a range of policy tools, including foreign exchange intervention (FXI) and capital flow management tools (CFMs), to mitigate the effects of volatile capital flows on their economies. We develop an empirically-oriented New Keynesian model to evaluate and quantify how using multiple policy tools can potentially improve monetary policy tradeoffs. Our model embeds nonlinear balance sheet channels and includes a range of empirically-relevant frictions. We show that FXI and CFMs may improve policy tradeoffs under certain conditions, especially for economies with less well-anchored inflation expectations, substantial foreign currency mismatch, and that are more vulnerable to shocks likely to induce capital outflows and exchange rate pressures.

Unconventional Policy Instruments in the New Keynesian Model
Unconventional Policy Instruments in the New Keynesian Model

Author: Zineddine Alla

Publisher: International Monetary Fund

Published: 2016-03-10

Total Pages: 34

ISBN-13: 1513573039

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This paper analyzes the use of unconventional policy instruments in New Keynesian setups in which the ‘divine coincidence’ breaks down. The paper discusses the role of a second instrument and its coordination with conventional interest rate policy, and presents theoretical results on equilibrium determinacy, the inflation bias, the stabilization bias, and the optimal central banker’s preferences when both instruments are available. We show that the use of an unconventional instrument can help reduce the zone of equilibrium indeterminacy and the volatility of the economy. However, in some circumstances, committing not to use the second instrument may be welfare improving (a result akin to Rogoff (1985a) example of counterproductive coordination). We further show that the optimal central banker should be both aggressive against inflation, and interventionist in using the unconventional policy instrument. As long as price setting depends on expectations about the future, there are gains from establishing credibility by using any instrument that affects these expectations.

Inflation Targeting and Exchange Rate Management In Less Developed Countries
Inflation Targeting and Exchange Rate Management In Less Developed Countries

Author: Mr.Marco Airaudo

Publisher: International Monetary Fund

Published: 2016-03-08

Total Pages: 65

ISBN-13: 1475523165

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We analyze coordination of monetary and exchange rate policy in a two-sector model of a small open economy featuring imperfect substitution between domestic and foreign financial assets. Our central finding is that management of the exchange rate greatly enhances the efficacy of inflation targeting. In a flexible exchange rate system, inflation targeting incurs a high risk of indeterminacy where macroeconomic fluctuations can be driven by self-fulfilling expectations. Moreover, small inflation shocks may escalate into much larger increases in inflation ex post. Both problems disappear when the central bank leans heavily against the wind in a managed float.

Patterns of Foreign Exchange Intervention under Inflation Targeting
Patterns of Foreign Exchange Intervention under Inflation Targeting

Author: Gustavo Adler

Publisher: International Monetary Fund

Published: 2020-05-29

Total Pages: 29

ISBN-13: 1513536451

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The paper documents the use of foreign exchange intervention (FXI) across countries and monetary regimes, with special attention to its use under inflation targeting (IT). We find significant differences between advanced and emerging market economies, with the former group conducting FXI limitedly and broadly symmetrically, while the use of this policy instrument in emerging market countries is pervasive and mostly asymmetric (biased towards purchasing foreign currency, even after taking into account precautionary motives). Within emerging markets, the use of FXI is common both under IT and non-IT regimes. We find no evidence of FXI being used in response to inflation developments, while there is strong evidence that FXI responds to exchange rates, indicating that IT central banks in EMDEs have dual inflation/exchange rate objectives. We also find a higher propensity to overshoot inflation targets in emerging market economies where FXI is more pervasive.

Macroeconomic Impact of Foreign Exchange Intervention: Some Cross-country Empirical Findings
Macroeconomic Impact of Foreign Exchange Intervention: Some Cross-country Empirical Findings

Author: Mr. Zhongxia Jin

Publisher: International Monetary Fund

Published: 2021-04-30

Total Pages: 28

ISBN-13: 1513571958

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Based on VAR analyses across 26 countries, we show that, although foreign exchange intervention (FXI) is effective in stabilizing the nominal exchange rate in the short run, its impacts on the real exchange rate are less significant: Limitations on nominal exchange rate flexibility may induce adjustments to the real exchange rate through domestic prices. We find that countries that intervene more heavily in response to external shocks experience greater general and asset price volatility, which is not conducive to countering the impact of external shocks. We show that China’s macroeconomic responses to external shocks are broadly consistent with international experiences among intervening countries. The simple methodological framework adopted in this paper is meant to examine a broad set of macroeconomic variables and bears limitations; our findings serve to motivate more structural analysis on FXI’s macroeconomic impacts going forward.

Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework
Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework

Author: Mr.Jaromir Benes

Publisher: International Monetary Fund

Published: 2013-01-14

Total Pages: 43

ISBN-13: 147553812X

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We study a wide range of hybrid inflation-targeting (IT) and managed exchange rate regimes, analyzing their implications for inflation, output and the exchange rate in the presence of various domestic and external shocks. To this end, we develop an open economy new-Keynesian model featuring sterilized interventions in the foreign exchange (FX) market as an additional central bank instrument operating alongside the Taylor rule, and affecting the economy through portfolio balance sheet effects in the financial sector. We find that there can be advantages to combining IT with some degree of exchange rate management via FX interventions. 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. However, managing the exchange rate through FX interventions may also hinder necessary exchange rate adjustments, e.g., in the presence of terms of trade shocks.