Regulatory Policy Choices Amid Exchange Rate Volatility

Central banks in emerging market economies (EMEs) must achieve multiple goals under external constraints, requiring a broad, coordinated set of policy tools. I examine one such tool—limits and requirements on FX positions—by building a new dataset based on a survey and interviews I conducted with central banks and regulatory authorities from 17 Latin American and Caribbean countries, covering 1992–2012. These countries preferred policies that reduced long FX positions, mainly by directly limiting them rather than encouraging reductions through easier rules on short positions. The main goals of these policies were addressing currency mismatches and managing FX fluctuations, with the latter becoming more important as countries adopted more flexible FX regimes—a non-obvious result, since under fixed regimes, central banks usually try to limit fluctuations to reduce the FX reserves needed to defend the currency peg. Using the dataset and the synthetic control method to account for unobservable, time-varying country-specific factors, I show that FX regulations affected FX volatility.