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Managing Capital Outflows with Limited Reserves

Suman S. Basu (), Atish R. Ghosh (), Jonathan Ostry () and Pablo E. Winant ()
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Suman S. Basu: International Monetary Fund
Atish R. Ghosh: International Monetary Fund
Pablo E. Winant: Bank of England

IMF Economic Review, 2018, vol. 66, issue 2, 333-374

Abstract: Abstract We analyze the optimal intervention policy for an emerging market central bank that wishes to stabilize the exchange rate during a capital outflow episode, but possesses limited reserves. We show that adding a non-negativity constraint on reserves onto a simple linear-quadratic framework generates a time consistency problem. A central bank with full commitment achieves a gradual depreciation to the pure-float level by promising sustained future intervention, such that reserves are exhausted after particularly adverse shocks. A central bank without commitment intervenes little, wishing to preserve some reserves forever, so it suffers a larger immediate depreciation and achieves lower welfare. For more persistent shocks, the time consistency problem is greater, and simple intervention rules can achieve welfare gains relative to discretion.

Keywords: E44; F31; F32 (search for similar items in EconPapers)
Date: 2018
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