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Announcements are not Enough: Foreign Exchange Intervention under Imperfect Credibility

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Abstract

Central banks in emerging countries frequently build-up (diminish) reserves while attempting to depreciate (appreciate) their domestic currencies. Even if these interventions are effective, they often entail various costs. Basu (2012), nonetheless, proposes a model in which the sole announcement of an intervention schedule leads to a desired exchange rate without actually buying or selling foreign currency. In this paper we present a generalization that allows for imperfect credibility of foreign exchange intervention. Namely, market dealers know that the central bank carries strategic incentives when announcing its schedule and may not perfectly believe it. We show that, under this setup, it may be impossible for central banks to achieve the desired exchange rate level without changing their position of international reserves.

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  • Jose E. Gomez-Gonzalez & Julian A. Parra-Polania & Mauricio Villamizar-Villegas, 2016. "Announcements are not Enough: Foreign Exchange Intervention under Imperfect Credibility," Borradores de Economia 949, Banco de la Republica de Colombia.
    • Handle: RePEc:bdr:borrec:949
    DOI: 10.32468/be.949
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    1. Charles Engel, 2011. "Currency Misalignments and Optimal Monetary Policy: A Reexamination," American Economic Review, American Economic Association, vol. 101(6), pages 2796-2822, October.
    2. Devereux, Michael B., 2004. "Should the exchange rate be a shock absorber?," Journal of International Economics, Elsevier, vol. 62(2), pages 359-377, March.
    3. Basu, Kaushik, 2012. "How to devalue exchange rates, without building up reserves: Strategic theory for central banking," Economics Letters, Elsevier, vol. 117(3), pages 758-761.
    4. Garcia, Carlos J. & Restrepo, Jorge E. & Roger, Scott, 2011. "How much should inflation targeters care about the exchange rate?," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1590-1617.
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    Cited by:

    1. Wenbo Wang & Dieu Thanh Le & Hail Park, 2020. "Is Foreign Exchange Intervention a Panacea in Diversified Circumstances? The Perspectives of Asymmetric Effects," Sustainability, MDPI, vol. 12(7), pages 1-20, April.

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    More about this item

    Keywords

    Exchange rate; Foreign exchange intervention; Central bank Credibility; Credibility function;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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