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. To motivate the topic, we estimate a structural VAR model that identifies both short-term and long-term FX intervention shocks by foreign countries in US dollar bonds. We find that positive short-term FX interventions lead to lower GDP in both the US and foreign region, while positive long-term FX interventions lead to higher GDP in both the US and foreign region. We then propose a two-region theoretical model with portfolio balance effects, calibrated to match the US and its trade partners, and show that FX interventions in the model lead to effects that are consistent with these empirical results. 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.

Keywords: Exchange Rates, Foreign Exchange Interventions, Open Economy Macroeconomics, Monetary Policy, Term Premium