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Interdependencies between Monetary Policy and Foreign Exchange Intervention under Inflation Targeting: The Case of Brazil and the Czech Republic

  • Gnabo, Jean-Yves
  • de Mello, Luiz
  • Moccero, Diego

The bulk of recent literature on foreign exchange interventions has overlooked the potential interdependencies that may exist between these operations and the conduct of monetary policy. This is the case even under inflation targeting and especially in emerging-market economies, because central banks often explicitly reserve the right to intervene to calm disorderly markets and to accumulate foreign reserves, and when the exchange rate is perceived as being out of step with fundamentals. This paper uses a friction model to estimate intervention reaction functions and the associated marginal effects for Brazil and the Czech Republic since the adoption of inflation targeting in these countries in 1999 and 1998, respectively. The main findings are that: (i) in both countries interventions occur predominantly to reduce exchange rate volatility, while in Brazil the central bank also reacts to exchange rate deviations from medium-term trends; (ii) there are strong, asymmetric threshold effects in the reaction functions, and interventions are more likely and of higher magnitudes when they are carried out to depreciate than to appreciate the domestic currency; and (iii) interventions seem to take place independently of contemporaneous monetary policy in Brazil, but not in the Czech Republic, where both policies appear to be interrelated.

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File URL: http://www.wider.unu.edu/stc/repec/pdfs/rp2008/rp2008-95.pdf
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Paper provided by World Institute for Development Economic Research (UNU-WIDER) in its series Working Paper Series with number RP2008/95.

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Length: 28 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:unu:wpaper:rp2008-95
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  1. Dominguez, Kathryn M.E., 2006. "When do central bank interventions influence intra-daily and longer-term exchange rate movements?," Journal of International Money and Finance, Elsevier, vol. 25(7), pages 1051-1071, November.
  2. Rasmus Fatum & Michael M. Hutchison, . "Is Intervention a Signal of Future Monetary Policy? Evidence from the Federal Funds Futures Market," EPRU Working Paper Series 96-13, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  3. Beine, Michel & Bernal, Oscar & Gnabo, Jean-Yves & Lecourt, Christelle, 2009. "Intervention policy of the BoJ: A unified approach," Journal of Banking & Finance, Elsevier, vol. 33(5), pages 904-913, May.
  4. Christopher J. Neely, 2005. "An analysis of recent studies of the effect of foreign exchange intervention," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 685-718.
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  6. Rasmus Fatum & Michael Hutchison, 2003. "Effectiveness of Official Daily Foreign Exchange Market Intervention Operations in Japan," NBER Working Papers 9648, National Bureau of Economic Research, Inc.
  7. Christopher J. Neely, 2006. "Identifying the effects of U.S. intervention on the levels of exchange rates," Working Papers 2005-031, Federal Reserve Bank of St. Louis.
  8. Robert M. de Jong & Tiemen Woutersen, 2007. "Dynamic time series binary choice," Economics Working Paper Archive 538, The Johns Hopkins University,Department of Economics.
  9. Michel Beine & Agnes Bénassy-Quéré & Christelle Lecourt, 2002. "Central Bank intervention and foreign exchange rates: new evidence from FIGARCH estimations," ULB Institutional Repository 2013/10445, ULB -- Universite Libre de Bruxelles.
  10. Tomas Holub, 2004. "Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience," Research and Policy Notes 2004/01, Czech National Bank, Research Department.
  11. Jong, Robert & Herrera, Ana María, 2011. "Dynamic Censored Regression and the Open Market Desk Reaction Function," Journal of Business & Economic Statistics, American Statistical Association, vol. 29(2), pages 228-237.
  12. Oscar Bernal Diaz & Jean-Yves Gnabo, 2007. "Talks, financial operations or both? Generalizing central banks' FX reaction functions," DULBEA Working Papers 07-03.RS, ULB -- Universite Libre de Bruxelles.
  13. Oscar Bernal Diaz, 2006. "Do interactions between political authorities and central banks influence FX interventions? Evidence from Japan," DULBEA Working Papers 06-03.RS, ULB -- Universite Libre de Bruxelles.
  14. Ito, Takatoshi & Yabu, Tomoyoshi, 2007. "What prompts Japan to intervene in the Forex market? A new approach to a reaction function," Journal of International Money and Finance, Elsevier, vol. 26(2), pages 193-212, March.
  15. Luiz de Mello & Diego Moccero, 2007. "Monetary Policy and Macroeconomic Stability in Latin America: The Cases of Brazil, Chile, Colombia and Mexico," OECD Economics Department Working Papers 545, OECD Publishing.
  16. Baillie, Richard T. & Osterberg, William P., 1997. "Why do central banks intervene?," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 909-919, December.
  17. Luiz De Mello & Diego Moccero, 2009. "Monetary Policy and Inflation Expectations in Latin America: Long-Run Effects and Volatility Spillovers," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 41(8), pages 1671-1690, December.
  18. Disyatat, Piti & Galati, Gabriele, 2007. "The effectiveness of foreign exchange intervention in emerging market countries: Evidence from the Czech koruna," Journal of International Money and Finance, Elsevier, vol. 26(3), pages 383-402, April.
  19. Mark P. Taylor & Lucio Sarno, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective and, If So, How Does It Work?," Journal of Economic Literature, American Economic Association, vol. 39(3), pages 839-868, September.
  20. Paul Bergin, 2004. "Measuring the costs of exchange rate volatility," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue aug20.
  21. Kearns, Jonathan & Rigobon, Roberto, 2005. "Identifying the efficacy of central bank interventions: evidence from Australia and Japan," Journal of International Economics, Elsevier, vol. 66(1), pages 31-48, May.
  22. M. S. Mohanty & Marc Klau, 2004. "Monetary policy rules in emerging market economies: issues and evidence," BIS Working Papers 149, Bank for International Settlements.
  23. Almekinders, G.J. & Eijffinger, S.C.W., 1996. "A friction model of daily Bundesbank and Federal Reserve intervention," Other publications TiSEM 9ca974cc-1549-4752-8dbe-0, Tilburg University, School of Economics and Management.
  24. Dominguez, Kathryn M., 1998. "Central bank intervention and exchange rate volatility1," Journal of International Money and Finance, Elsevier, vol. 17(1), pages 161-190, February.
  25. Balazs Egert & Lubos Komarek, 2005. "Foreign Exchange Interventions and Interest Rate Policy in the Czech Republic: Hand in Glove?," Working Papers 2005/07, Czech National Bank, Research Department.
  26. Oecd, 2006. "Monetary Policy and Inflation Expectations in Latin America: Long-run Effects and Volatility Spillovers," OECD Economics Department Working Papers 518, OECD Publishing.
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