Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework

By Jaromir Benes, Andrew Berg, Rafael A Portillo, David Vávra

January 14, 2013

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Jaromir Benes, Andrew Berg, Rafael A Portillo, and David Vávra. Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework, (USA: International Monetary Fund, 2013) accessed December 3, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We study a wide range of hybrid inflation-targeting (IT) and managed exchange rate regimes, analyzing their implications for inflation, output and the exchange rate in the presence of various domestic and external shocks. To this end, we develop an open economy new-Keynesian model featuring sterilized interventions in the foreign exchange (FX) market as an additional central bank instrument operating alongside the Taylor rule, and affecting the economy through portfolio balance sheet effects in the financial sector. We find that there can be advantages to combining IT with some degree of exchange rate management via FX interventions. Unlike "pure" IT or exchange rate management via interest rates, FX interventions can help insulate the economy against certain shocks, especially shocks to international financial conditions. However, managing the exchange rate through FX interventions may also hinder necessary exchange rate adjustments, e.g., in the presence of terms of trade shocks.

Subject: Banking, Central bank policy rate, Exchange rate arrangements, Exchange rates, Financial services, Foreign exchange, Real exchange rates

Keywords: Central bank policy rate, Corridor simulation, Eastern Europe, Emerging markets, Exchange rate arrangements, Exchange rate corridor, Exchange rate depreciation, Exchange rate intervention, Exchange rate market, Exchange rate movement, Exchange rate targeting, Exchange rate volatility, Exchange rates, Global, Interest rate instrument, Interest rate premium, Interest rate rule, Interest rate shock, Managed float, Monetary policy, New-Keynesian economics, Real exchange rates, Sterilized FX interventions, WP

Publication Details

Pages:

43
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2013/011
Stock No:

WPIEA2013011
ISBN:

9781475545401
ISSN:

1018-5941

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