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We investigate the effectiveness of sterilized foreign exchange interventions by exploiting a discontinuous policy rule used by the Central Bank of Colombia (CBoC). We use a unique data set from CBoC comprised of tick by tick intervention and order book data, daily capital in-and outflow data, and balance sheet information of financial institutions. We apply regression discontinuity methods to identify the surprise component of rule based exchange rate interventions of the CBoC and use this variation to measure how interventions affect exchange rates and capital flows. At horizons of a few days, our empirical findings support sterilized exchange rate intervention effectiveness via a portfolio channel. The exchange rate effects we see are short-lived. At horizons of a month or longer, capital flows originating from foreign investors restore the exchange rate back to its original level. Our findings also show that the effects of sterilized interventions are amplified by capital controls. A methodological contribution of the paper is to extend regression discontinuity designs to a time series environment and to show how these techniques can be used to identify and estimate non-linear impulse response functions. from the Central Bank of Colombia (Banco de la Republica) for answering numerous questions. The views expressed herein are those of the authors and not necessarily those of the Banco de la República nor its Board of Directors. All errors and omissions remain our responsibility.

The opinions contained in this document are the sole responsibility of the authors and do not commit Banco de la República nor its Board of Directors.

Many central banks, particularly in the developing world, aim for exchange rate stability as a macroeconomic goal. However, most are reluctant to relinquish monetary policy autonomy, so they end up operating through both interest rate and foreign exchange interventions. But the use of multiple policy instruments does not necessarily equip monetary authorities with better tools to achieve their targets. On the contrary, their effects can potentially offset each other. Using daily data from the Central Bank of Colombia during the period of 1999-2012, I study the effects of simultaneous policies by first deriving new measures of monetary shocks and then determining their impact on economic activity. The main findings indicate that (a) while interest rate interventions have a significant impact on real and nominal variables, foreign exchange interventions tend to have limited effects; and (b) empirical anomalies, such as the positive relationship between output growth, inflation, and the policy rate are eliminated when properly accounting for the systematic responses of policy. (JEL E43, E52, E58, F31) But it remains a fact that compared to conventional policy the effects of unconventional monetary policy are very limited and uncertain -Olivier Blanchard 1