Patterns of Foreign Exchange Intervention under Inflation Targeting

Abstract

The paper documents the use of foreign exchange intervention (FXI) across countries and monetary regimes, with special attention to its use under inflation targeting (IT). We find significant differences between advanced and emerging market economies, with the former group conducting FXI limitedly and broadly symmetrically, while the use of this policy instrument in emerging market countries is pervasive and mostly asymmetric (biased towards purchasing foreign currency, even after taking into account precautionary motives). Within emerging markets, the use of FXI is common both under IT and non-IT regimes. We find no evidence of FXI being used in response to inflation developments, while there is strong evidence that FXI responds to exchange rates, indicating that IT central banks in EMDEs have dual inflation/exchange rate objectives. We also find a higher propensity to overshoot inflation targets in emerging market economies where FXI is more pervasive.

Central bank securities and foreign exchange market intervention in a developing economy

“…6 Another aspect of this literature considers whether FXI could work effectively under inflation targeting (Adler et al, 2019(Adler et al, , 2020Ghosh et al, 2016;Ostry et al, 2012). Doubts remain, nevertheless; and in that context, compared with FX interventions, we feel that one-sided CBB sales could be more consistent with an inflation objective, particularly when the exchange rate is appreciating because of capital inflows.…”

Natural Disasters and Financial Stress: Can Macroprudential Regulation Tame Green Swans?

“…Dummy variable equal to 1 once a country has adopted inflation targeting (0 otherwise). Source: Roger (2009); Schmidt-Hebbel and Carrasco (2016); Adler et al (2020).…”

Toward an Integrated Policy Framework

“…Country authorities report that they use (sterilized) FXI for a multitude of objectives including (i) inflation control; (ii) building reserves; (iii) muting volatility in shallow FX markets; (iv) preserving financial stability in the presence of balance sheet mismatches; and (v) preventing overvaluation of the currency that may hurt competitiveness (Hofman et al, 2020;Poirson et al, forthcoming). Data suggests that interventions in EMDEs tend to be asymmetric, leaning more often against currency appreciation during inflow periods than against depreciation during outflows (Adler, Chang et al, 2020;Adler et al, forthcoming;Chamon et al, 2019;, possibly motivated by the objective to build reserves. Evidence suggests that countries with higher reserves face less asset price and capital flow volatility than those with low reserves (Sahay et al, 2014).…”