How to move the exchange rate if you must: the diverse practice of foreign exchange intervention by central banks and a proposal for doing it better

Kaushik Basu and Aristomene Varoudakis

No 6460, Policy Research Working Paper Series from The World Bank

Abstract: The paper is about the art of exchange rate management by central banks. It begins by reviewing the diversity of objectives and practices of central bank intervention in the foreign exchange market. Central banks typically exercise discretion in determining when and to what extent to intervene. Some central banks use publicly declared rules of intervention, with the aim of increasing visibility and strengthening the signaling channel of policy. There is tentative evidence that the volatility of foreign exchange reserves is comparatively lower in emerging market economies where central banks follow some form of rules-based foreign exchange intervention. The paper goes on to argue that when the foreign exchange market includes some large strategic participants, the central bank can achieve superior outcomes if intervention takes the form of a rule, or"schedule,"indicating commitments to buying and selling different quantities of foreign currency conditional on the exchange rate. Exchange rate management and reserve management can then be treated as two independent objectives by the central bank. In line with the stylized facts reviewed, this would enable a central bank to pursue exchange rate objectives with minimum reserve changes, or achieve reserve targets with minimum impact on the exchange rate.

Keywords: Debt Markets; Emerging Markets; Currencies and Exchange Rates; Economic Stabilization; Economic Theory&Research (search for similar items in EconPapers)
Date: 2013-05-01
New Economics Papers: this item is included in nep-cba and nep-mon
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Citations: View citations in EconPapers (10)

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