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FX Intervention in the New Keynesian Model

Author

Listed:
  • Zineddine Alla
  • Raphael A Espinoza
  • Atish R. Ghosh

Abstract

We develop an open economy New Keynesian Model with foreign exchange intervention in the presence of a financial accelerator mechanism. We obtain closed-form solutions for the optimal interest rate policy and FX intervention under discretionary policy, in the face of shocks to risk appetite in international capital markets. The solution shows that FX intervention can help reduce the volatility of the economy and mitigate the welfare losses associated with such shocks. We also show that, when the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high. We determine the conditions under which indeterminacy can occur and highlight how the use of FX intervention reinforces the central bank’s credibility and limits the risk of multiple equilibria.

Suggested Citation

  • Zineddine Alla & Raphael A Espinoza & Atish R. Ghosh, 2017. "FX Intervention in the New Keynesian Model," IMF Working Papers 17/207, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:17/207
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Two papers on exchange rate policy
      by Christian Zimmermann in NEP-DGE blog on 2017-12-14 23:34:59

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    Cited by:

    1. Jalali Naini, Ahmad Reza & Naderian, Mohammad Amin, 2017. "Financial Vulnerability and Stabilization Policy in Commodity Exporting Emerging Economies," MPRA Paper 84481, University Library of Munich, Germany.

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