Foreign Exchange Interventions: The Long and the Short of it

Abstract

This paper examines the effects of foreign exchange (FX) interventions in a setting where agents exchange both short-term and long-term securities. In a two-region theoretical model, calibrated to match the US and its trade partners (foreign region), we show that FX interventions by the foreign region do not have standard beggar-thy-neighbor consequences. Purchases of short-term FX reserves lead to lower GDP in both regions, whereas purchases of long-term FX reserves lead to higher GDP in both regions. These results are driven by the impact of these interventions on the term premium channel, which dominates the trade balance channel in our calibrated model. Finally, we estimate a structural VAR model that identifies both short-term and long-term FX intervention shocks, and find GDP responses to these shocks that are consistent with our theoretical predictions.

Keywords: codes: F31, F33, F41