2022-07-28-IMF-Exchange-Rate_Swings_and_Foreign_Currency_Intervention_41页_4mb

Exchange-Rate Swings and Foreign Currency Intervention

Summary:
This paper examines the effectiveness of foreign currency intervention (FXI) in influencing the real exchange rate (REER) across different economic cycles, analyzing data from 26 advanced and emerging economies between 1990 and 2018.

Key findings:

1. Cycle-Specific Misalignments: The paper introduces a novel approach to measure exchange rate misalignments by decomposing real exchange rates into short-run (1-4 years), medium-run (4-10 years), and long-run (≥10 years) cycles using band spectrum regression methods.

2. Effectiveness of Intervention: FX interventions are effective primarily at mitigating short-run misalignments. A one-off FX intervention of 10 percent of GDP (e.g., FX purchases) leads to a statistically significant 1.5-4.5 percent depreciation in the exchange rate for a 10 percent short-run misalignment.

3. Persistent and Large Interventions: Persistent (ongoing over quarters) and large-scale interventions enhance effectiveness. FX sales are generally more impactful than purchases. Market liquidity (low spread) also amplifies the effect of interventions, especially for short-run misalignments.

4. Cross-Sectional Differences: Asian economies show higher intervention effectiveness compared to Latin American ones. Countries with managed float regimes respond more effectively to interventions than those with floating regimes.

5. Policy Implications: Central banks should focus interventions on short-run cycles, as medium and long-run misalignments are less responsive. Policies should account for market depth, cycle-specific factors, and intervention scale.

The paper highlights that FXI is effective against short-run misalignments induced by financial frictions but less so for long-run misalignments driven by fundamentals.