Responding to Exchange Rates in a Globalised World

21 Pages Posted: 6 Oct 2014

See all articles by Michael B. Devereux

Michael B. Devereux

University of British Columbia (UBC) - Department of Economics; Centre for Economic Policy Research (CEPR)

James Yetman

Bank for International Settlements (BIS)

Date Written: March 2014

Abstract

How should monetary policy respond to nominal exchange rates? How does this change as economies become increasingly globalised? In this paper, we address these questions for Asia, focusing on structural changes that may influence the optimal policy response to exchange rates. We also summarise some new results based on an analytical model outlined in Devereux and Yetman (2014b) designed to address these issues. We show that sterilised intervention can be a potent tool that offers policymakers an additional degree of freedom in maximising global welfare. We illustrate how the gains to sterilised intervention can be sensitive to various aspects of goods and financial market structure. When financial internationalisation is high, the gains to sterilised intervention fall. And at the limit of perfect financial integration, the gains from sterilised intervention are entirely eliminated. Unsterilised intervention may also have a role to play, and may continue to work even in cases where sterilised intervention is rendered ineffective. Many central banks in Asia have actively used sterilised foreign exchange intervention as a policy tool for smoothing exchange rate movements. This is a policy that appears to have served the region well. But, over time, structural changes in the region, including increased goods market integration, declining exchange rate pass-through and ongoing internationalisation of financial markets are likely to reduce the efficacy of sterilised intervention. More generally, these structural changes may call into question the appropriate role of exchange rates in monetary policy setting in the region.

Full publication: Globalisation, Inflation and Monetary Policy in Asia and the Pacific

Keywords: globalisation, foreign exchange intervention, exchange rate pass through

JEL Classification: E58, F62

Suggested Citation

Devereux, Michael B. and Yetman, James, Responding to Exchange Rates in a Globalised World (March 2014). BIS Paper No. 77h, Available at SSRN: https://ssrn.com/abstract=2474032

Michael B. Devereux (Contact Author)

University of British Columbia (UBC) - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR)

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James Yetman

Bank for International Settlements (BIS) ( email )

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Basel, Basel-Stadt 4002
Switzerland

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