Managing Capital Outflows: The Role of Foreign Exchange Intervention

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

No 756, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We analyze the optimal intervention policy for an emerging market central bank which wishes to stabilize the exchange rate in response to a capital outflow shock, but possesses limited reserves. Using a stylized framework which nests various forms of limited capital mobility, we derive a time inconsistency problem, and we compare outcomes under full, zero and partial commitment. A central bank with full commitment achieves a gentle exchange rate depreciation to the pure float level by promising a path of sustained intervention, including a commitment to exhaust reserves after particularly adverse shocks. A central bank without commitment intervenes less, wishing instead to preserve at least some reserves forever, and suffers a larger exchange rate depreciation. For more persistent shocks, the time inconsistency problem is larger, and simple intervention rules can achieve welfare gains relative to discretion.

Date: 2016
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-sog
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:756

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