The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Gustavo Adler, Ruy Lama, and Juan Pablo Medina Guzman
INTERNATIONAL MONETARY FUND
We study the use of foreign exchange (FX) intervention as an additional policy instrument in an
environment with learning, where agents infer the central bank policy rules from its policy actions.
Under full information, a central bank focused on stabilizing output and inflation can achieve
better outcomes by using FX intervention as an additional policy tool. Under policy uncertainty,
where agents perceive that monetary policy may also have exchange rate stabilization goals, the
use of FX intervention entails a trade-off, reducing output volatility while increasing inflation
volatility. While having an additional policy tool is always beneficial, we find that the optimal
magnitude of intervention is higher in monetary policy regimes with lower uncertainty. These
results indicate that the benefits of using FX intervention as an additional stabilization tool are
greater in regimes where monetary policy is credibly focused on output and inflation stabilization.