Vanishing central bank intervention in stochastic impulse control

Gregory Gagnon ()
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Gregory Gagnon: University of Toronto Mississauga

Annals of Finance, 2019, vol. 15, issue 1, No 5, 125-153

Abstract: Abstract Stochastic control of exchange rates when a central bank employs anti-inflationary stochastic differential equation (SDE) monetary policy is the key topic of our paper. Despite low money growth SDE policy means exchange rates invariably violate the central bank’s targets. Monetary policy also incorporates interventions reflected by sudden money supply jumps that moderate deviations from targets. Controlling exchange rates involves minimizing target deviation and intervention costs. Restrictions on these costs ensure intervention vanishes under the optimal control, implying the central bank engineers freely floating exchange rates instead of managed floating or fixed exchange rates. Econometric evidence suggests discretionary interventions may be ineffective or generate excess volatility and speculation in currency markets. Our result demonstrates mathematically that such collateral damage discourages intervention.

Keywords: Stochastic impulse control; Semimartingale; Value function (search for similar items in EconPapers)
JEL-codes: C61 E58 F31 G12 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1007/s10436-018-0327-2

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