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How to move the exchange rate if you must: the diverse practice of foreign exchange intervention by central banks and a proposal for doing it better

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  • Basu, Kaushik
  • Varoudakis, Aristomene

Abstract

The paper is about the art of exchange rate management by central banks. It begins by reviewing the diversity of objectives and practices of central bank intervention in the foreign exchange market. Central banks typically exercise discretion in determining when and to what extent to intervene. Some central banks use publicly declared rules of intervention, with the aim of increasing visibility and strengthening the signaling channel of policy. There is tentative evidence that the volatility of foreign exchange reserves is comparatively lower in emerging market economies where central banks follow some form of rules-based foreign exchange intervention. The paper goes on to argue that when the foreign exchange market includes some large strategic participants, the central bank can achieve superior outcomes if intervention takes the form of a rule, or"schedule,"indicating commitments to buying and selling different quantities of foreign currency conditional on the exchange rate. Exchange rate management and reserve management can then be treated as two independent objectives by the central bank. In line with the stylized facts reviewed, this would enable a central bank to pursue exchange rate objectives with minimum reserve changes, or achieve reserve targets with minimum impact on the exchange rate.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 6460.

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Date of creation: 01 May 2013
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Handle: RePEc:wbk:wbrwps:6460

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Related research

Keywords: Debt Markets; Emerging Markets; Currencies and Exchange Rates; Economic Stabilization; Economic Theory&Research;

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  1. Basu, Kaushik & Morita, Hodaka, 2005. "International Credit and Welfare: A Paradoxical Theorem and Its Policy Implications," Working Papers, Cornell University, Center for Analytic Economics 05-04, Cornell University, Center for Analytic Economics.
  2. Koray Alper & Hakan Kara & Mehmet Yorukoglu, 2013. "Reserve Options Mechanism," Central Bank Review, Research and Monetary Policy Department, Central Bank of the Republic of Turkey, vol. 13(1), pages 1-14.
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