Modelling the impact of central bank intervention on exchange rate volatility under inflation targeting

Katusiime, Lorna; Agbola, Frank W.

doi:10.1080/00036846.2018.1450482

Cited by 8 publications

(5 citation statements)

References 29 publications

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“…The reason is to be found in the reserve option mechanism. Yet, there is also evidence that the Central Bank reduces the exchange volatility by means of the net activity in the interbank foreign exchange market (Katusiime and Agbola, 2018).…”

Section: Theoretical Backgroundmentioning

confidence: 99%

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

Capasso

Napolitano

Jiménez

2019

JES

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Purpose The purpose of this paper is to analyse the long-term nature of the interrelationship between interest rate and exchange rate. Design/methodology/approach By employing Mexican data, the authors estimate a non-linear autoregressive distributed lags (NARDL) model to investigate the nature of the changes and the interaction between interest rate and exchange rate in response to monetary authorities’ actions. Findings The results show that, contrary to simplistic predictions, the real exchange rate causes the real interest rate in an asymmetric way. The bounds testing approach of the NARDL models suggests the presence of co-integration among the variables and the exchange rate variations appear to have significant long-run effects on the interest rate. Most importantly, these effects are asymmetric and positive variations in the exchange rate have a lower impact on the interest rate. It is also interesting to report that the reverse is not true: the interest rate in the long-run exerts no statistical significant impact on the exchange rate. Practical implications The asymmetric long-term relationship between real exchange rate and real interest rate is evidence of why monetary authorities are reluctant to free float exchange rate. In Mexico, as in most developing countries, monetary policy strongly responds to exchange rate movements because these have relevant effects on commercial trade. Moreover, in dollarized economies these effects are stronger because of pass-through impacts to inflation, income distribution and balance-sheet equilibrium (the well-known “original sin”). Originality/value Under inflation targeting and flexible exchange rate regime, despite central banks pursue the control of short-term interest rate, in the long-run one could observe that it is the exchange rate that influences the interest rate, and that this reverse causality is stronger in emerging economies. This paper contributes by analysing the asymmetric relationship between the variables.

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Section: Theoretical Backgroundmentioning

confidence: 99%

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

Capasso

Napolitano

Jiménez

2019

JES

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“…Section 5 provides concluding observations and recommendations for future research based on empirical research in this paper. Katusiime & Agbola (2018) show that foreign exchange interventions a mixed impact on the volatility of the exchange rate and find that inflation targeting is capable of curbing temporary exchange rate shocks. Empirical results indicate that while order flow is capable of reducing exchange rate volatility, an increase in the operating target rate tends to exacerbate exchange rate volatility.…”

Section: Introductionmentioning

confidence: 94%

Central Bank Intervention in the Inflation Targeting

Krušković¹

2022

Journal of Central Banking Theory and Practice

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This paper analyses the impact of central bank interventions in the inflation targeting regime. The results of empirical studies in this paper show if there is a shock of the exchange rate, which would lead to depreciation of the exchange rate, a central bank may decide to mush instability on the foreign exchange market with foreign exchange interventions, thereby preventing the sudden exchange rate depreciation, which would then require a smaller reaction by the interest rate. Namely, through foreign exchange interventions, the central bank greatly absorbs the depreciation shock and, consequently, inflation is lower. As a result of lower price growth, the need for a monetary policy response to an interest rate is also lower. Based on this example, we can see that central bank intervention in some cases can be very useful in order to correct disturbances in the foreign exchange market. Therefore, some central banks accumulate foreign exchange reserves at a very high level so as to have enough space for foreign exchange intervention, without the risk of falling foreign exchange reserves below the optimum level.

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“…When only the p-value was reported, we followed the procedure in Vooren et al (2019) to convert p-values as follows: p-values below and up to 0.01 were assigned t-statistics of 2.58, p-values between 0.01 and 0.05 were assigned t-statistics of 1.96, p-values between 0.05 and 0.10 were assigned t-statistics of 1.65, and p-values above 0.10 were assigned t-statistics of 0.99. Among the literature we found studies that reported standard errors with zero value, possibly due to rounding or limited decimals in their reports (Aguilar and Nydahl, 2000, Kriljenko et al, 2006, Hoshikawa, 2008, Trivedi and Apte, 2016, Katusiime and Agbola, 2018. For these we used a 2.58 t-statistic threshold instead.…”

Section: Web-searchmentioning

confidence: 99%

The effectiveness of FX interventions: A meta-analysis

Arango-Lozano¹,

Menkhoff

Rodriguez-Novoa³

et al. 2020

Journal of Financial Stability

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There is ample empirical literature centering on the effectiveness of foreign exchange intervention (FXI). Given the mix of objectives and country-heterogeneity, the general lack of consensus thus far is no surprise. We shed light on this debate by conducting the first comprehensive meta-analysis in the FXI literature, with 279 reported effects that stem from 74 distinct empirical studies. We cover estimations conducted in 19 countries across five decades. Overall, our meta-survey reports an average depreciation of domestic currency of 1% and a reduction of exchange rate volatility of 0.6%, in response to a $1 billion US dollar purchase. Results are qualitatively confirmed but smaller in size under fixed and random-effect estimations. When narrowing in on different economic factors, we find that effects are magnified for cases consistent with the monetary trilemma (greater if financial openness and monetary independence are low). Effects are also larger in emerging than advanced economies, when banking crises remain mild, and when interventions are large in size and are announced.

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Modelling the impact of central bank intervention on exchange rate volatility under inflation targeting

Cited by 8 publications

References 29 publications

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

The long-run interrelationship between exchange rate and interest rate: the case of Mexico

Central Bank Intervention in the Inflation Targeting

The effectiveness of FX interventions: A meta-analysis

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