Going Unconventional in Foreign-Exchange Interventions
Journal of International Business and Law, 18(2), 185-216
32 Pages Posted: 16 Aug 2019
Date Written: July 1, 2019
Much has been said about unconventional monetary policy. But what about unconventional exchange-rate policy? More specifically, what about central banks using derivatives to avoid excessive currency volatility? The Central Bank of Brazil (BCB) has resorted to it for more than 15 years now, as I reveal in this article.
Since 2002, the BCB uses swaps to provide stability to the foreign-exchange market — the BCB FX swap. These swaps offer the BCB an alternative to trading U.S. dollars in the spot market, a traditional policy tool that can quickly lose its effectiveness when markets are frothy. By the end of 2015, 2.1 million BCB FX swap contracts were outstanding, with an aggregate notional amount of near US$110 billion — around 7% of Brazilian GDP.
A government agency acting to implement public policies while holding a multibillion-dollar derivatives exposure faces multiple risks. But the risks are worth taking. In times of extensive financial globalization, every instrument that can be used to soften the effects of global capital flows matters.
In consequence, countries as different as Switzerland, Argentina, Venezuela, and China may find in Brazil some useful lessons about managing currency volatility with an unconventional tool.
Keywords: central bank, currency volatility, exchange-rate policy, foreign-exchange intervention, derivatives
JEL Classification: E58, F31, O24
Suggested Citation: Suggested Citation