A Theoretical Approach to Sterilized Foreign Exchange Intervention

23 Pages Posted: 29 Jan 2017

Date Written: February 2017

Abstract

In this paper, we survey prominent theories that have shaped the literature on sterilized foreign exchange interventions. We identify three main strands of literature: (1) that which deems interventions futile; (2) that which requires some market friction (i.e. limited arbitrage) in order for interventions to be effective; and (3) that which advocates the use of interventions as long as they convey signals on the stance of future monetary policy. We contribute to the literature in three important ways. First, by reviewing new theoretical models that have surfaced within the last decade. Second, by further penetrating into the theory of interventions in order to analyze the key features that make each model distinct. And third, by only focusing on sterilized operations, which allows us to sidestep the effects induced by changes in the stock of money supply. In addition, the models that we present comprise both a macro and microstructure approach so as to provide a comprehensive view of the theory behind exchange rate intervention.

Keywords: Impossible trinity, Portfolio balance channel, Signaling channel; Sterilized foreign exchange intervention, Uncovered interest rate parity

Suggested Citation

Villamizar‐Villegas, Mauricio and Perez‐Reyna, David, A Theoretical Approach to Sterilized Foreign Exchange Intervention (February 2017). Journal of Economic Surveys, Vol. 31, Issue 1, pp. 343-365, 2017, Available at SSRN: https://ssrn.com/abstract=2907162 or http://dx.doi.org/10.1111/joes.12136

Mauricio Villamizar‐Villegas (Contact Author)

Central Bank of Colombia ( email )

Carrera 7 No. 14-78 Piso 11
Bogotá
Colombia

David Perez‐Reyna

Universidad de los Andes, Colombia ( email )

Carrera 1# 18A-10
Bogotá, DC
Colombia

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