Foreign Exchange Intervention Rules for Central Banks: A Risk-based Framework

Foreign Exchange Intervention Rules for Central Banks: A Risk-based Framework
Author: Romain Lafarguette
Publisher: International Monetary Fund
Total Pages: 33
Release: 2021-02-12
Genre: Business & Economics
ISBN: 1513569406
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This paper presents a rule for foreign exchange interventions (FXI), designed to preserve financial stability in floating exchange rate arrangements. The FXI rule addresses a market failure: the absence of hedging solution for tail exchange rate risk in the market (i.e. high volatility). Market impairment or overshoot of exchange rate between two equilibria could generate high volatility and threaten financial stability due to unhedged exposure to exchange rate risk in the economy. The rule uses the concept of Value at Risk (VaR) to define FXI triggers. While it provides to the market a hedge against tail risk, the rule allows the exchange rate to smoothly adjust to new equilibria. In addition, the rule is budget neutral over the medium term, encourages a prudent risk management in the market, and is more resilient to speculative attacks than other rules, such as fixed-volatility rules. The empirical methodology is backtested on Banco Mexico’s FXIs data between 2008 and 2016.

Foreign Exchange Intervention as a Monetary Policy Instrument

Foreign Exchange Intervention as a Monetary Policy Instrument
Author: Felix Hüfner
Publisher: Springer Science & Business Media
Total Pages: 194
Release: 2004
Genre: Business & Economics
ISBN: 9783790801286
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Foreign exchange intervention is frequently being used by central banks in countries which have a floating exchange rate. Most theoretical monetary policy models, however, do not take this phenomenon into account. This book contributes to closing this gap between theory and practice by interpreting foreign exchange intervention as an additional monetary policy instrument for inflation targeting central banks. In-depth empirical analyses of the foreign exchange operations and interest rate policy of five inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) demonstrate how foreign exchange intervention is used in practice.

The Cost of Foreign Exchange Intervention

The Cost of Foreign Exchange Intervention
Author: Gustavo Adler
Publisher: International Monetary Fund
Total Pages: 37
Release: 2016-04-12
Genre: Business & Economics
ISBN: 148433230X
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The accumulation of large foreign asset positions by many central banks through sustained foreign exchange (FX) intervention has raised questions about its associated fiscal costs. This paper clarifies conceptual issues regarding how to measure these costs both from an ex-post and an ex-ante (relevant for decision making) perspective, and estimates both marginal and total costs for 73 countries over the period 2002-13. We find ex-ante marginal costs for the median emerging market economy (EME) in the inter-quartile range of 2-5.5 percent per year; while ex-ante total costs (of sustaining FX positions) in the range of 0.2-0.7 percent of GDP per year for light interveners and 0.3-1.2 percent of GDP per year for heavy interveners. These estimates indicate that fiscal costs of sustained FX intervention (via expanding central bank balance sheets) are not negligible.

Official Intervention in the Foreign Exchange Market

Official Intervention in the Foreign Exchange Market
Author: Roberto Pereira Guimarães
Publisher: International Monetary Fund
Total Pages: 45
Release: 2003-07-01
Genre: Business & Economics
ISBN: 145185711X
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This paper offers guidance on the operational aspects of official intervention in the foreign exchange market, particularly in developing countries with flexible exchange rate regimes. A brief survey of the literature and country experience is followed by an analysis of the objectives, timing, amount, degree of transparency, and choice of markets and counterparties in conducting intervention. The analysis highlights the difficulty of detecting exchange rate misalignments and disorderly markets, and argues in favor of parsimony in official intervention. Determining the timing and amount of intervention is a highly subjective excercise, and some degree of discretion is almost necessary, though policy rules may serve as "rules of thumb."

Foreign Exchange Intervention under Policy Uncertainty

Foreign Exchange Intervention under Policy Uncertainty
Author: Gustavo Adler
Publisher: International Monetary Fund
Total Pages: 40
Release: 2016-03-17
Genre: Business & Economics
ISBN: 1475520417
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We study the use of foreign exchange (FX) intervention as an additional policy instrument in an environment with learning, where agents infer the central bank policy rules from its policy actions. Under full information, a central bank focused on stabilizing output and inflation can achieve better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty, where agents perceive that monetary policy may also have exchange rate stabilization goals, the use of FX intervention entails a trade-off, reducing output volatility while increasing inflation volatility. While having an additional policy tool is always beneficial, we find that the optimal magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These results indicate that the benefits of using FX intervention as an additional stabilization tool are greater in regimes where monetary policy is credibly focused on output and inflation stabilization.

The Effectiveness of Central Bank Interventions in the Foreign Exchange Market

The Effectiveness of Central Bank Interventions in the Foreign Exchange Market
Author: Dave Arnold Seerattan
Publisher:
Total Pages:
Release: 2012
Genre:
ISBN:
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The global foreign exchange market is the largest financial market with turnover in this market often outstripping the GDP of countries in which they are located. The dynamics in the foreign exchange market, especially price dynamics, have huge implications for financial asset values, financial returns and volatility in the international financial system. It is therefore an important area of study. Exchange rates have often departed significantly from the level implied by fundamentals and exhibit excessive volatility. This reality creates a role for central bank intervention in this market to keep the rate in line with economic fundamentals and the overall policy mix, to stabilize market expectations and to calm disorderly markets. Studies that attempt to measure the effectiveness of intervention in the foreign exchange market in terms of exchange rate trends and volatility have had mixed results. This, in many cases, reflects the unavailability of data and the weaknesses in the empirical frameworks used to measure effectiveness. This thesis utilises the most recent data available and some of the latest methodological advances to measure the effectiveness of central bank intervention in the foreign exchange markets of a variety of countries. It therefore makes a contribution in the area of applied empirical methodologies for the measurement of the dynamics of intervention in the foreign exchange market. It demonstrates that by using high frequency data and more robust and appropriate empirical methodologies central bank intervention in the foreign exchange market can be effective. Moreover, a framework that takes account of the interactions between different central bank policy instruments and price dynamics, the reaction function of the central bank, different states of the market, liquidity in the market and the profitability of the central bank can improve the effectiveness of measuring the impact of central bank policy in the foreign exchange market and provide useful information to policy makers.

Official Foreign Exchange Intervention

Official Foreign Exchange Intervention
Author: Mr.Jorge Iván Canales Kriljenko
Publisher: International Monetary Fund
Total Pages: 58
Release: 2006-03-02
Genre: Business & Economics
ISBN: 9781589064218
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Despite increasing exchange rate flexibility, central banks in emerging markets still intervene in their foreign exchange markets for several reasons. In doing so, they face many operational questions, including on the degree of transparency and the choice of markets and counterparties. This paper identifies elements of best practice in official foreign exchange intervention, presents survey evidence on intervention practices in developing countries, and assesses the effectiveness of intervention in Mexico and Turkey.

The Cost of Foreign Exchange Intervention

The Cost of Foreign Exchange Intervention
Author: Gustavo Adler
Publisher: International Monetary Fund
Total Pages: 37
Release: 2016-04-08
Genre: Business & Economics
ISBN: 1484323076
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The accumulation of large foreign asset positions by many central banks through sustained foreign exchange (FX) intervention has raised questions about its associated fiscal costs. This paper clarifies conceptual issues regarding how to measure these costs both from an ex-post and an ex-ante (relevant for decision making) perspective, and estimates both marginal and total costs for 73 countries over the period 2002-13. We find ex-ante marginal costs for the median emerging market economy (EME) in the inter-quartile range of 2-5.5 percent per year; while ex-ante total costs (of sustaining FX positions) in the range of 0.2-0.7 percent of GDP per year for light interveners and 0.3-1.2 percent of GDP per year for heavy interveners. These estimates indicate that fiscal costs of sustained FX intervention (via expanding central bank balance sheets) are not negligible.

Money Market Interventions

Money Market Interventions
Author: Markus Bruetsch
Publisher: GRIN Verlag
Total Pages: 24
Release: 2003-06-30
Genre: Business & Economics
ISBN: 3638201481
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Essay from the year 2003 in the subject Business economics - Banking, Stock Exchanges, Insurance, Accounting, grade: 1,5 (A), Oxford Brookes University (Business School), course: Synoptic Essays in International Banking & Finance, language: English, abstract: After the collapse of the Bretton-Woods-System in 1973 and the transition to a system of floating rates between the major global currencies, central banks still use interventions for exchange rate maintenance. This paper aims to examine the function of Central Bank operations in foreign exchange markets on the basis of two empirical data sets, explaining both, appreciation and depreciation. It tries to analyse the impacts on capital flows recorded in the balance of payments and the efficiency of interventions. Further it will analyse the impacts on domestic monetary supplies and if necessary how to sterilise these effects. At certain stages endnotes will refer to the appendix for more detailed explanations or data. To illustrate, how central bank interventions work, we will take the European Central Bank (ECB) as an example and concentrate on two currencies, the euro (€) and the US dollar ($). [...] If the ECB aims at an appreciation of the own currency, the bank will engage in a foreign exchange operation and buy euros against its US dollar reserves. The demand for euros increases (demand curve shifts to the right) and simultaneously supply is reduced, because the ECB takes Euro out of the market (supply curve shifts to the left). Through the forces of supply and demand the value of the euro will strengthen in international markets (the exchange rate moves from r1 to r2). Depreciation (see diagram 2) If the ECB aims at a depreciation of the own currency, the bank will sell euros against dollars. In this case, demand for euros declines (demand curve shifts to left) and the supply increases (shift to the right) because the ECB pays the purchased dollars in euro. Again, the forces of supply and demand determine the new exchange rate at r2. The value of the euro will weaken in international markets (and inversely the US dollar value will rise). [...]