Applied Seminar

Pablo Winant (with Suman Bas, Atish Rex Gosh and Jonathan Ostry)

Bank of England

29-May-2018

Seminar 1 – 14:00

Abstract

We analyze the optimal intervention policy for an emerging market central bank which wishes to stabilize the exchange rate in response to a capital outflow shock, but possesses limited reserves. Using a stylized framework, we show that the zero lower bound on reserves combined with limited capital mobility generates a time inconsistency problem, and we compare outcomes under full, zero and partial commitment. A central bank with full commitment achieves a gradual exchange rate depreciation to the pure float level by promising a path of sustained intervention, including a commitment to exhaust reserves after particularly adverse shocks. A central bank without commitment intervenes less, wishing instead to preserve at least some reserves forever, and suffers a larger exchange rate depreciation. For more persistent shocks, the time inconsistency problem is larger, and simple intervention rules can achieve welfare gains relative to discretion. We relate the optimal intervention policy to the composition of investors in the FX market.

Download pdf
Leave Comment

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

clear formSubmit