Foreign Exchange Intervention Under Policy Uncertainty

41 Pages Posted: 26 Apr 2016

See all articles by Gustavo Adler

Gustavo Adler

International Monetary Fund (IMF) - Research Department

Ruy Lama

International Monetary Fund (IMF)

Juan Medina

Adolfo Ibanez University

Date Written: March 2016

Abstract

We study the use of foreign exchange (FX) intervention as an additional policy instrument in anenvironment with learning, where agents infer the central bank policy rules from its policy actions.Under full information, a central bank focused on stabilizing output and inflation can achievebetter outcomes by using FX intervention as an additional policy tool. Under policy uncertainty,where agents perceive that monetary policy may also have exchange rate stabilization goals, theuse of FX intervention entails a trade-off, reducing output volatility while increasing inflationvolatility. While having an additional policy tool is always beneficial, we find that the optimalmagnitude of intervention is higher in monetary policy regimes with lower uncertainty. Theseresults indicate that the benefits of using FX intervention as an additional stabilization tool aregreater in regimes where monetary policy is credibly focused on output and inflation stabilization.

Keywords: Foreign Exchange Intervention, Monetary Policy, Learning, inflation, central bank, exchange, currency, Open Economy Macroeconomics,

JEL Classification: E58, F31, F41

Suggested Citation

Adler, Gustavo and Lama, Ruy and Medina, Juan, Foreign Exchange Intervention Under Policy Uncertainty (March 2016). IMF Working Paper No. 16/67. Available at SSRN: https://ssrn.com/abstract=2770300

Gustavo Adler

International Monetary Fund (IMF) - Research Department ( email )

700 19th Street NW
Washington, DC 20431
United States

Ruy Lama

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Juan Medina (Contact Author)

Adolfo Ibanez University ( email )

Diagonal Las Torres 2640 Peñaleón
Presidente Errázuriz 3485 Las Condes
Santiago, 794-1169
Chile

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