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Optimal Foreign Exchange Intervention in an In fl ation Targeting Regime : some cautionary tales ∗
| Content Provider | Semantic Scholar |
|---|---|
| Author | Canzoneri, Matthew B. Cumby, Robert E. |
| Copyright Year | 2013 |
| Abstract | Devaluations and fiscal retrenchments coming from developed countries are buffeting less developed countries. Many emerging market countries have adopted inflation targeting as “best practice,” but now they are being advised to enhance their inflation targeting regimes with foreign exchange intervention. Here we use a DSGE model to tell some cautionary tales about this advice. A Taylor rule guides interest rate setting, while foreign exchange interventions are used as a second tool of monetary policy. These interventions are effective in our model since domestic and key currency bonds are imperfect substitutes. We derive optimal (Ramsey) intervention policies in response to foreign deflations and fiscal retrenchments, and find that they are rather complex. So, we compare the optimal responses to policies that simply smooth real or nominal exchange rate movements. Our results suggest that discretion may be the better part of valor: pure inflation targeting may come closer to the optimal policy than exchange rate smoothing. A secondary result may also be of some interest: foreign exchange interventions have a stronger impact on inflation and output in an inflation targeting regime than do sterilized interventions; the Taylor rule augments the effects of a given intervention. ∗We thank Mauricio Villamizer Villegas and especially Behzad Diba for helpful comments. But we are solely responsible for the contents of this paper. †Georgetown University, canzonem@georgetown.edu ‡Georgetown University, cumbyr@georgetown.edu |
| File Format | PDF HTM / HTML |
| Alternate Webpage(s) | http://faculty.georgetown.edu/canzonem/intervention_policy.pdf |
| Language | English |
| Access Restriction | Open |
| Content Type | Text |
| Resource Type | Article |
