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Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework

Author

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  • Jaromir Benes
  • Andrew Berg
  • Rafael A Portillo
  • David Vavra

Abstract

We study a wide range of hybrid inflation-targeting (IT) and managed exchange rate regimes, analyzing their implications for inflation, output and the exchange rate in the presence of various domestic and external shocks. To this end, we develop an open economy new-Keynesian model featuring sterilized interventions in the foreign exchange (FX) market as an additional central bank instrument operating alongside the Taylor rule, and affecting the economy through portfolio balance sheet effects in the financial sector. We find that there can be advantages to combining IT with some degree of exchange rate management via FX interventions. Unlike "pure" IT or exchange rate management via interest rates, FX interventions can help insulate the economy against certain shocks, especially shocks to international financial conditions. However, managing the exchange rate through FX interventions may also hinder necessary exchange rate adjustments, e.g., in the presence of terms of trade shocks.

Suggested Citation

  • Jaromir Benes & Andrew Berg & Rafael A Portillo & David Vavra, 2013. "Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework," IMF Working Papers 13/11, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:13/11
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    More about this item

    Keywords

    Economic models; Emerging markets; Exchange markets; Exchange rate regimes; Central banks and their policies; Developing countries; Intervention; Inflation targeting; Monetary policy; Foreign exchange; Sterilized FX interventions; new-Keynesian economics; exchange rate; exchange rate targeting; exchange rate interventions; exchange rates; Monetary Policy (Targets; Instruments; and Effects);

    JEL classification:

    • 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
    • F31 - International Economics - - International Finance - - - Foreign Exchange

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