FX Intervention in the New Keynesian Model

Zineddine Alla, Raphael Espinoza and Atish Ghosh ()

No 2017/207, IMF Working Papers from International Monetary Fund

Abstract: We develop an open economy New Keynesian Model with foreign exchange intervention in the presence of a financial accelerator mechanism. We obtain closed-form solutions for the optimal interest rate policy and FX intervention under discretionary policy, in the face of shocks to risk appetite in international capital markets. The solution shows that FX intervention can help reduce the volatility of the economy and mitigate the welfare losses associated with such shocks. We also show that, when the financial accelerator is strong, the risk of multiple equilibria (self-fulfilling currency and inflation movements) is high. We determine the conditions under which indeterminacy can occur and highlight how the use of FX intervention reinforces the central bank’s credibility and limits the risk of multiple equilibria.

Keywords: WP; risk premium; central bank; Central bank reserves; Speculative attack; Portfolio balance model; Equilibrium determinacy; Capital flows; Capital controls; Open Economy New Keynesian Model.; FX intervention; risk premium shock; open economy; terms of trade; sterilized foreign exchange intervention; working capital; Consumption; Return on investment; Exchange rates; Inflation; Global (search for similar items in EconPapers)
Pages: 39
Date: 2017-09-29
References: Add references at CitEc
Citations: View citations in EconPapers (4)

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=45215 (application/pdf)

Related works:
Journal Article: FX Intervention in the New Keynesian Model (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:2017/207

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().