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Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience

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  • Tomas Holub

Abstract

This paper discusses the role of foreign exchange interventions in the inflation-targeting regime, focusing on the Czech experience since 1998. It proposes criteria for assessing whether the interventions are consistent with the inflation targeting. While the CNB's interventions in mid- 1998 and in 2002 pass these criteria easily, the judgement might be more uncertain concerning the interventions in early-1998 and in 1999/2000. It is also stressed that the literature on managed floating usually ignores the difficulty in defining clear procedural rules for the interventions. This contrasts with the procedures guiding the interest rate decisions under the inflation targeting regime, which may occasionally create tensions in the policy regime, as demonstrated by the Czech experience, too. The interventions' effectiveness in the Czech Republic is also discussed. It seems that sometimes they might have had an immediate impact lasting up to 2 or 3 months, but no strategy can be identified that would work in all episodes. Moreover, even many of the 'successful' interventions were not able to prevent quite prolonged periods of exchange rate overvaluation in 1998 and in 2002. It is concluded that the signalling role of foreign exchange interventions is more important than their 'market-equilibrating effect', implying a rather unstable transmission between the central bank actions and the market reactions. Finally, the paper analyses the sterilisation costs, which are shown to have been quite substantial in the Czech Republic. It is argued that the financial sustainability of the interventions is quite important for their credibility and effectiveness.

Suggested Citation

  • Tomas Holub, 2004. "Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience," Research and Policy Notes 2004/01, Czech National Bank.
  • Handle: RePEc:cnb:rpnrpn:2004/01
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    More about this item

    Keywords

    Exchange rate; foreign exchange interventions; inflation targeting; sterilisation.;
    All these keywords.

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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