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Reserve Option Mechanism as a Stabilizing Policy Tool : Evidence from Exchange Rate Expectations

  • Ahmet Degerli
  • Salih Fendoglu

During the recent era, many emerging market economies have implemented unconventional policy measures to mitigate the effect of large swings in short-term capital flows on domestic business cycles. This paper focuses on a specific unconventional policy tool introduced by the Central Bank of Turkey, the Reserve Option Mechanism (ROM), that in principle contains excessive fluctuations in foreign exchange rate and helps cushion the economy from large swings in external factors. The results suggest that, after the introduction the ROM (i) market expectations are leaned towards a significantly lower volatility or skewness in the USD/TL relative to other emerging market exchange rates; (ii) controlling for a set of domestic and common external factors, the USD/TL expectations have exhibited lower levels of volatility, skewness and kurtosis; (iii) the higher the intensity of ROM (the fraction of ROM-based reserves in total international reserves) the stronger the effect of ROM on exchange rate expectations. Last, we provide evidence that the mechanism acts as an automatic stabilizer of expectations about excessive movements in the exchange rate: the mechanism decreases the sensitivity of expected USD/TL kurtosis to the common external factor (by an estimated decrease of about 85%).

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Paper provided by Research and Monetary Policy Department, Central Bank of the Republic of Turkey in its series Working Papers with number 1328.

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Date of creation: 2013
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Handle: RePEc:tcb:wpaper:1328
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