Speech

Foreign Exchange Intervention in Latin American Countries with Inflation Targets

March 8, 2019

It is a great pleasure to be here today among friends and colleagues to launch our new book on foreign exchange intervention in Latin America. I would like to thank Governor Diaz de Leon for hosting us and for so generously sharing the stage.

This book, and this event, are timely. At this moment of uncertainty about the global economy, it is useful to have a serious discussion of monetary and exchange rate policies—particularly the role of foreign exchange intervention in countries with inflation-targeting regimes. We have seen many twists and turns over the past year, including trade tensions and financial market volatility that sparked episodes of capital outflows from emerging market economies. In response, authorities have employed a variety of measures, including foreign exchange intervention.

The countries represented here today deserve tremendous credit for policies that enabled them to weather that storm. But the experience has underlined the challenges that central bankers and other policymakers must deal with continually in their quest for economic and financial stability.

An Integrated Policy Framework

Which is why this book is so germane as countries respond to these challenges. It is an important contribution to the Fund’s ongoing discussion of the policy toolkit needed to ensure stability. We have been giving more systematic thought to the complementarities and trade-offs between monetary, exchange rate, macroprudential and capital flow management policies; in other words, how to think about these tools in a more integrated way. This Integrated Policy Framework, as we call it, increasingly figures in our internal policy discussions, and we plan to have more interactions about it with officials like you.

Foreign exchange intervention is an element of that toolkit. Since the 1990s, most large Latin American economies have transitioned to inflation targeting with flexible exchange rates. In some cases, this transition came after crises that highlighted the shortcomings of pegged currency regimes.

Within this transition to inflation targeting, countries experimented with various degrees of exchange rate flexibility. While some rarely intervene anymore, some use it actively. But our understanding of many aspects of foreign exchange intervention remains limited. That’s why a study focused on this region is so useful. Latin America provides a wealth of information to compare the different approaches to intervention undertaken by inflation-targeting central banks

FX Intervention in the Region

Many countries in the region have accumulated reserves as they have sought to build buffers and to counterbalance sustained capital inflows. These flows initially came in response to the commodity super-cycle, and then as the advanced economies responded to the global financial crisis with monetary stimulus. In some countries, central banks deployed their reserves to counter depreciation pressures.

In some cases, foreign exchange intervention took place within a clear framework and under a defined set of rules. In others, it was more ad hoc and discretionary. Often, intervention took place directly in spot markets and was aimed at accommodating immediate foreign exchange liquidity needs. But in some episodes, pressures in foreign exchange markets were due to hedging demand, and that intervention was carried out through derivatives.

So, the book offers an overview of the issues countries had in common. Fund staff have written the introductory chapters, and experts from seven Latin American central banks—including institutions represented here today—have contributed summaries of their countries’ intervention policies, goals, and outcomes.

I think it is particularly instructive to compile in one place the decision-making processes of these institutions. And it offers a good example of policy institutions and decision makers collaborating, to learn from each other and advance our collective thinking.

Key Themes of the Book

A couple of key themes emerge: first, we see the benefits of a rules-based intervention relative to the discretionary intervention practiced in some of the region’s largest economies. In Mexico, for example, mechanisms have been used to accumulate reserves, reduce the pace of reserve accumulation through oil revenues, and address disorderly conditions in the foreign exchange market.

A second theme is the importance of transparency and strong communications policies in reducing exchange rate volatility and market uncertainty. The Latin American experience suggests this is especially relevant to avoid undermining the credibility of the inflation target. Of course, the centrality of communications is a lesson that applies well beyond Latin America intervention, as we have seen with the advanced economies’ use of unconventional monetary policies.

This is not a textbook, but an important accumulation of experience and expertise from practitioners on the cutting edge of an integrated policy. Today’s discussions will add to our understanding as we work together to strengthen our defenses against instability and disruption. And perhaps one day it will contribute to a true textbook for policymakers.

I look forward to hearing your ideas—and to a robust debate. Thank you.