Front Matter

Front Matter

Author(s):
Marcos Chamon, David Hofman, Nicolas Magud, and Alejandro Werner
Published Date:
February 2019
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Foreign Exchange Intervention in INFLATION TARGETERS in Latin America

EDITORS

Marcos Chamon, David Hofman, Nicolás E. Magud, and Alejandro Werner

INTERNATIONAL MONETARY FUND

Advanced Praise

“Over the past two decades, emerging market economies throughout the world have improved their economic performance and resilience through a combination of exchange-rate flexibility and inflation targeting. Yet, strictly free-floating remains rare, and the revealed preference is sometimes to use foreign exchange intervention as an additional policy tool. When are these interventions helpful, and what practices make it more likely they will complement rather than undermine the pursuit of price stability? With a focus on Latin America, this book provides vital background to help answer these questions. It is essential reading for anyone who wants to understand how emerging economies can navigate the global financial cycle.”

Maury Obstfeld

Professor of Economics at the University of California Berkley

“Emerging markets’ road to development involves consolidating an open economy in terms of trade and capital flows. This requires a sound macroeconomic framework, in which a strong monetary policy anchor (such as an inflation-targeting scheme implemented by an autonomous central bank), sustainable fiscal accounts and a market-based flexible exchange rate arrangement play a key role. For this to be effective, it is critical to (i) develop a deep and liquid foreign exchange market; (ii) build an efficient regulatory framework aimed at increasing financial and corporate foreign exchange resilience (which often constrains policy alternatives); and (iii) consider foreign exchange interventions and capital flow management measures as exceptions, to be used only when distortions could compromise an adequate foreign exchange price discovery process and not to target any foreign exchange level. In this context, this book is an invaluable contribution to the analysis of experiences of Latin American countries regarding the evolution of their foreign exchange policies. Overall, the region has made progress in developing their financial markets and adopting stronger foreign exchange regimes.”

Alejandro Díaz de León

Governor of the Central Bank of Mexico

Foreign Exchange Intervention in Inflation Targeters in Latin America

EDITORS

Marcos Chamon, David Hofman, Nicolás E. Magud, and Alejandro Werner

© 2019 International Monetary Fund

Cover design: IMF Creative Services

Cataloging-in-Publication Data IMF Library

Names: Chamon, Marcos, editor. | Hofman, David (David J. V.), editor. | Magud, Nicolás E., editor. | Werner, Alejandro, editor. | International Monetary Fund, publisher.

Title: Foreign exchange intervention in inflation targeters in Latin America / editors: Marcos Chamon, David Hofman, Nicolás E. Magud, and Alejandro Werner.

Description: [Washington, DC] : International Monetary Fund, [2019]. | Includes bibliographical references.

Identifiers: ISBN 9781484375686 (paper) | ISBN 9781484393024 (ePub) | ISBN 9781484393031 (Mobi) | ISBN 9781484393048 (PDF)

Subjects: LCSH: Foreign exchange—Latin America. | Inflation (Finance)—Latin America. | Inflation targeting—Latin America.

Classification: LCC HG3851.F674 2019

DISCLAIMER: The views expressed in this book are those of the authors and do not necessarily represent the views of the IMF’s Executive Directors, its management, or any of its members. The boundaries, colors, denominations, and any other information shown on the maps do not imply, on the part of the International Monetary Fund, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries.

Recommended citation: Chamon, Marcos, David Hofman, Nicolás E. Magud, and Alejandro Werner, eds. 2019. Foreign Exchange Intervention in Inflation Targeters in Latin America. Washington, DC: International Monetary Fund.

ISBN: 978-1-48437-568-6 (paper)

978-1-48439-302-4 (ePub)

978-1-48439-303-1 (Mobi)

978-1-48439-304-8 (PDF)

Please send orders to:

International Monetary Fund, Publication Services

P.O. Box 92780, Washington, D.C. 20090, U.S.A.

Tel.: (202) 623–7430 Fax: (202) 623–7201

E-mail: publications@imf.org

Internet: www.elibrary.imf.org

www.bookstore.imf.org

Contents

Foreword

Latin America has explored many different exchange rate arrangements over the history of the Bretton Woods period. The International Monetary System established by the 1944 Bretton Woods agreement was based on fixed but adjustable exchange rates. In those days, frequent foreign exchange intervention was simply a mechanical consequence of the choice of an exchange rate regime. Starting in the 1970s, however, advanced economies moved to more flexible exchange rates. At the same time, many developing countries sought to maintain fixed regimes to provide stability and control inflation, though not always successfully. Since the 1990s, sometimes in the aftermath of currency crises that highlighted the drawbacks of prior pegged regimes, most large Latin American economies have transitioned to inflation targeting. By construction, an inflation-targeting framework requires exchange rate flexibility. It is thus no longer clear what role—if any— foreign exchange intervention should play.

In practice, inflation-targeting central banks in emerging markets have continued to closely monitor the exchange rate, not only because of its implications for inflation, but also because of financial stability risks that sharp exchange rate movements may entail. For the most part, foreign exchange intervention has continued to be a widely used instrument in the toolkit of policymakers in these countries. Despite this widespread use, our understanding of many aspects related to this tool remains limited. In that setting, the wide variety of approaches taken by Latin American countries provides a wealth of experience for study and analysis.

Building on a comprehensive review of the evidence and practices related to foreign exchange intervention in Latin America, this new book compares country experiences and facilitates the policy discussion. Analytical chapters written by IMF staff review the main themes that emerge from the experience. Expert staff from seven key central banks in the region contributed chapters that review in more detail the goals, modalities, evolution, and outcomes of intervention policies in their respective countries.

This book documents why and how Latin American policymakers have continued to intervene in foreign exchange markets and how they have reconciled this with the primary goal of inflation targeting. Their experience is diverse, and several aspects require further research. Yet, key central themes that emerge are the importance of transparency and strong communication policies, as well as the benefits of rules-based intervention observed in the largest economies. These have arguably helped central banks in the region to strengthen the effectiveness of interventions and preserve the credibility of their monetary policy regimes. This book offers a wealth of information for central banks, including those outside the region, and for anyone else interested in learning from the Latin American experience. I hope you will find it useful.

David Lipton

First Deputy Managing Director

International Monetary Fund

Acknowledgments

We thank Gaston Gelos for valuable suggestions and discussion, as well as Heidi Canelas and Maria Gutierrez for their excellent administrative support, and Ana Maria Trujillo and Diego Wachs for superb research assistance. Linda Kean and Rumit Pancholi provided us invaluable editorial support.

Marcos Chamon, David Hofman, Nicolás E. Magud, and Alejandro Werner

Editors

Contributors

Editors

Marcos Chamon is Deputy Division Chief of the Systemic Issues Division of the Research Department at the IMF. He was previously the Mission Chief for Guyana in the Western Hemisphere Department. His work covers a wide range of topics on international finance, including problems related to sovereign debt restructuring, debt composition and liability denomination, currency mismatches, and international financial architecture. His work also includes vulnerability assessment in emerging markets and advanced economies, consumption and savings, distributional implications of exchange rate movements, the emerging market policy responses to the global financial crisis, the design of capital controls and macroprudential policies, and monetary policy and foreign exchange intervention in emerging markets. He was a visiting professor at the Pontifical Catholic University of Rio de Janeiro in the fall of 2007. He obtained a PhD in economics from Harvard University in 2003.

David Hofman is Deputy Division Chief in the Monetary and Macroprudential Policies Division of the Monetary and Capital Markets Department at the IMF, where he manages work on monetary and exchange rate policies. He previously worked in the IMF’s European Department as a Mission Chief for Belarus, Denmark, and Finland, and in the Strategy, Policy, and Review Department, where he focused on capital account and crisis resolution issues. Before joining the IMF in 2002, Mr. Hofman was an economist in the Financial Stability Department of the central bank of the Netherlands. He holds a doctorandus degree in economics from the University of Amsterdam.

Nicolás E. Magud is a Senior Economist in the Institute for Capacity Development at the IMF. He previously worked on Latin American countries and the Regional Studies Division in the Western Hemisphere Department at the IMF. Before that, he was a professor of international finance at the University of Oregon; associate professor at the University of Buenos Aires; a teaching assistant at the University Torcuato Di Tella in Argentina; an advisor to the Cabinet Secretariat and the Secretariat of Small and Medium-Sized Enterprises in Argentina; and an analyst at Citibank and at the Ministry of Economy of Argentina. His research focuses on open economy macroeconomics, with an emphasis on exchange rates, capital flows, capital controls, credit booms, and fiscal policy. He has also worked on topics in international trade and income distribution. He holds a PhD and an MA from the University of Maryland, an MA from the University Torcuato Di Tella, and a licen-sure from the University of Buenos Aires.

Alejandro Werner has been Director of the Western Hemisphere Department at the IMF since 2013. He is a Mexican national who has had distinguished careers in the public and private sectors, as well as in academia. He served as Undersecretary of the Office of Finance and Public Credit of Mexico (December 2006 through August 2010) and as Head of Corporate and Investment Banking at BBVA-Bancomer (August 2011 until the end of 2012). He was previously Director of Economic Studies at the Bank of Mexico and a professor at ITAM (Instituto de Empresa) and at Yale University. In 2007, he was named a Young Global Leader by the World Economic Forum. Dr. Werner received a PhD from the Massachusetts Institute of Technology in 1994.

Authors

Jaime Acosta is a researcher in the Directorate General of Central Bank Operations and Payment Systems at the Bank of Mexico. His research focuses on applied monetary policy by developing models that complement the directorate analysis presented to the Central Bank Board. In addition, his work involves analyzing the effects of financial market conditions on the Mexican peso. He holds a PhD in economics and MA degrees in statistics and in economics from Rice University.

Adrian Armas is the Executive Director for Argentina, Bolivia, Chile, Paraguay, Peru, and Uruguay on the IMF Board. Before joining the IMF in December 2017, he served as Chief Economist of the Central Reserve Bank of Peru (2005– 17), where he had spent almost his entire career (since 1986). Previously he was Head of the Monetary Policy Division (1997–2005) and Chief of the Financial Programming section (1995–97) at the central bank. He has helped lead the design and implementation of Peru’s inflation-targeting scheme and has written articles on this subject and others related to central banking for the IMF; the Bank for International Settlements; Economía, the journal of the Latin American and Caribbean Economic Association; and several central banks. He has participated in IMF Technical Assistance missions as Monetary and Capital Markets Advisor between 2007 and 2017. Also, he taught econometrics, international economics, macroeconomics, and monetary theory at several universities in Peru. He received an MA in political economy from Boston University in 1992.

João Barroso is Head of the International Affairs Department of the Central Bank of Brazil. He is responsible for assessing the international economic outlook for the Monetary Policy Committee, the Financial Stability Committee, and the International Reserves Active Allocation Committee—having established quantitative modeling and forecasting in the department. He represents the institution in international organizations and forums, manages international technical co-operation, and directly oversees cross-border financial integration initiatives, including international payments, contingent reserve arrangements, and financial service liberalization agreements. He is the former Deputy Head of the Research Department and its Head of Financial Stability Research, and responsible for research on financial stability, international economics, and macroprudential policy. He is the former Economic Advisor at the Governor’s Office, with hands-on policy experience during critical years of the global financial crisis. He has written several policy-motivated publications on a range of topics, including capital flows, monetary policy spillovers, international portfolio allocation, exchange rate dynamics, exchange rate intervention, tradable goods pricing, trade liberalization, external sustainability, macroprudential policy, and systemic risk in domestic and global financial networks. He has a PhD in economics from the Graduate School of Economics at Fundação Getúlio Vargas.

Elizabeth Bucacos is a Senior Economist at the Economic Research Area of the Central Bank of Uruguay. She teaches economic development at Universidad de Montevideo and time-series econometrics in the master’s program in the Economics Department of the Facultad de Ciencias Sociales at Universidad de la Republica. Her research interests include monetary policy, inflation, the connections between macroeconomics and finance, business cycles, productivity, and economic growth. She received a PhD in economics from Georgetown University.

Rodrigo Cano has been Director of Operation Support at the Directorate General of Central Bank Operations and Payment Systems at the Bank of Mexico since 2014. Before that, he was manager of the Financial Programing Division. He served as Head of the Domestic Foreign Exchange Operations Subdivision, where he was responsible for overseeing the implementation of foreign exchange interventions. With almost 20 years of experience at the Central Bank of Mexico, he has followed closely the analysis and implementation of foreign exchange intervention during these years. He earned an MA in economics from New York University in 2001.

Pamela Cardozo has been Deputy Governor for Monetary Operations and International Investments at the Central Bank of Colombia since 2010, where she supervises the departments of financial stability, reserve management, operations and markets’ developments, and financial infrastructures oversight. She earned a PhD in economics from Queen’s University.

Rodrigo Cubero has been President (Governor) of the Central Bank of Costa Rica since August 2018. Before that, he worked at the IMF for more than 12 years, where he held various positions in the Western Hemisphere Department, Asia and Pacific Department, and the Institute for Capacity Development. Previously he was a university lecturer (assistant professor) at the University of Oxford (2002–05) and manager in the tax department of KPMG, Costa Rica (1995–97). His research has focused on the economics of foreign direct investment, international finance, monetary and exchange rate economics, and fiscal policy and redistribution. He holds a PhD in economics from the University of Oxford, an MA in international economics from the University of Essex, and undergraduate degrees from the University of Costa Rica and Universidad Autónoma de Centroamérica.

Daniela Gallardo is Manager of the Financial Programing Division at the Central Bank of Mexico, which is responsible for forecasting items on the central bank balance sheet that affect liquidity and for making recommendations to the Board about medium-term sterilization strategy. Before that, she managed the Financial Markets Subdivision. She holds an MA in economics from New York University.

Alberto Graña is the Manager of the Economic Policy and Markets Division at the Central Bank of Uruguay, a division that designs and implements monetary policy, manages the assets and liabilities of the central bank, and regulates and supervises the payments systems. He is a member of the Public Debt Coordination Committee convened by the Central Bank of Uruguay and the Ministry of Economy and Finance. Between January 2014 and April 2015, he was appointed Governor of the Central Bank of Uruguay. Alberto is a professor of macroeconomics and public finances at the School of Economics of the Universidad de la República in Montevideo. He graduated from the University of Lund.

Oscar A. Hendrick is a Senior Economist in the Western Hemisphere Department at the IMF. He has many years of experience with IMF programs and bilateral surveillance. He has been a senior desk economist for several Latin American and Caribbean countries, including Colombia, Costa Rica, El Salvador, Panama, Suriname, and Trinidad and Tobago. During his tenure as Alternate Executive Director for Argentina, Bolivia, Chile, Paraguay, Peru, and Uruguay at the IMF, he was deeply engaged with lending policies and the modernization of the IMF toolkit for surveillance. He was also a member of the Board of the G24 Liaison Office from 1998 to 2001, and Chairman of the G24 Deputies at the 2000 Ministerial Meeting in Prague, the Czech Republic, on behalf of Peru. Dr. Hendrick has also worked in different positions at the Central Reserve Bank of Peru for several years, including as technical secretariat for the Monetary and Exchange Rate Policy Committee. He also worked in the Ministry Economy and Finance of Peru as General Director of Public Debt and member of the Board of Directors of Banco de la Nacion. He was also a professor of international economics and corporate finance at Universidad Del Pacifico and Universidad Catolica in Peru. He is a recipient of Fulbright and Ford Foundation scholarships. He has a PhD in economics and international finance from Rice University. He completed his undergraduate studies at the Universidad del Pacifico in Lima-Peru.

Sergi Lanau is Deputy Chief Economist in the Economic Research Department at the Institute of International Finance. He worked previously an economist at the IMF, where he was involved in the design and implementation of IMF programs in Greece and Latvia. He also worked on issues related to Italy, Latin America, and general emerging markets. Before joining the IMF, Dr. Lanau was an economist in the International Finance Division at the Bank of England. He earned a PhD in economics from Universitat Pompeu Fabra in 2008.

Valerie Lankester is an economist in the Research Department of the Central Bank of Costa Rica. She joined the central bank in October 2015. Before that, she had worked in a stock brokerage firm as an analyst. She was also a consultant for two of the main think tanks in Costa Rica: Programa Estado de la Nación and Academia de Centroamérica. Her research has focused on sovereign debt, fiscal policy effectiveness, and exchange rates. She has a PhD in economics, an MSc in financial economics, and another MSc in political economy, all from the University of Essex.

Catalina Larraín is an advisor at the General Secretariat of the Presidency of Chile. She previously worked as an economist in the Research Division of the Central Bank of Chile. She holds a BSc in economics and an MS from the Catholic University of Chile.

Gerardo Licandro has been Head of the Economic Research Area of the Central Bank of Uruguay since 2005. Before that, he held a position as Chief of the Studies Department of the Central Bank of Uruguay. He teaches monetary theory and policy at the master’s program in the Economics Department of the Facultad de Ciencias Sociales of the Universidad de la República and at the Universidad Católica del Uruguay. He holds a PhD in economics from the University of California, Los Angeles.

Miguel Mello is a Senior Economist from the Economic Research Area of the Central Bank of Uruguay. He also teaches microeconomics at the University of Montevideo. He has an MSc from the Carlos III University of Madrid, and a BSc in economics from the Republic University of Uruguay.

Evelyn Muñoz has been Director of the Economic Research Department of the Central Bank of Costa Rica since 2009. She supervises the research and macro-economic modeling and forecasting process. Her research has focused on inflation targeting, monetary policy, and macroeconomic modeling. She holds an MS in economics with a specialization in banking and capital markets from the University of Costa Rica.

Asad Qureshi is a Senior Financial Sector Expert in the Monetary and Capital Markets Department at the IMF, where he works on foreign exchange interventions, official reserve management, financial market developmental issues, and other areas. He has contributed to diverse cross-functional and IMF-wide projects, such as review of special drawing rights policy and inclusion of the renminbi in the special drawing rights basket, central banks’ use of foreign exchange swaps, exchange rate developments and policies in the Caucasus and Central Asia, and review of IMF policies on multiple currency practices. Before joining the IMF, he served as an executive director of the Financial Markets and Reserves Management Group at the State Bank of Pakistan, overseeing the central bank’s operations in domestic and international markets. He chaired the Open Market Operations Committee of the central bank and served as a member of various policy committees, including the Monetary Policy Committee, the Investment Committee, and the Debt Management Committee. Before his position at the central bank, he worked at several multinational private sector banks in treasury and investment banking, and his most recent position was Head of Global Financial Markets and Treasurer in the private sector in Pakistan.

Umang Rawat is an Economist in the Monetary and Capital Markets Department at the IMF, where he works on issues related to monetary, macroprudential, and exchange rate policies. He is also on the IMF country team for Georgia in the Middle East and Central Asia Department. He previously worked in the Asia and Pacific Department, covering Singapore, and as part of the IMF’s Regional Economic Outlook for Asia and the Pacific. He has also worked extensively on issues related to the IMF’s special drawing rights, including review of the renmin-bi’s inclusion into the special drawing rights basket. He holds a PhD in economics from the University of Cambridge.

Diego Saravia is Manager of Economic Research of the Central Bank of Chile, where he previously was a Senior Economist and Head of Modelling and Forecasting. Before that, he was a professor of economics at the Catholic University of Chile and an Economic Advisor at the Central Bank of Argentina. He obtained a PhD in economics from the University of Maryland at College Park.

Miklos Vari is an Economist in the Monetary and Capital Markets Department at the IMF, where he works on foreign exchange interventions, current account convertibility, central banks’ liquidity management, macroprudential policies, and other areas. Before joining the IMF, he served as an Economist at the Bank of France, in the Directorate of Monetary Policy and Financial Analysis and in the Directorate of International Analysis, where he contributed to the brief of the Governor for the European Central Bank Governing Council and to the academic research of the department. Before his position at the Bank of France, Dr. Vari worked in the Market Operations Department at the European Central Bank. There he worked on the Eurosystem’s interventions in distressed sovereign bond markets, on emergency liquidity assistance, and on collateral for refinancing operations. He holds an MS and a PhD from the Paris School of Economics.

Marco Vega is Deputy Manager of Economic Research in the Economic Studies Department at the Central Reserve Bank of Peru. He also holds a part-time position in the economics department at Pontificia Universidad Católica del Perú. His research concentrates on empirical macroeconomics and monetary policy. He has published in journals such as the International Journal of Central Banking, Journal of International Money and Finance, Empirical Economics, and Economía. He has a PhD in economics from the London School of Economics and an undergraduate degree in economic engineering from Universidad Nacional de Ingeniería in Peru.

Chris Walker is Deputy Division Chief in the Western Hemisphere Department at the IMF, where he is Mission Chief for Haiti. His previous responsibilities at the IMF included working as Desk Economist for Brazil and as Deputy Division Chief in the Global Market Analysis Unit. He has published papers on a range of monetary policy and financial markets issues, with a focus on derivatives markets. Before joining the IMF, he worked for the US Treasury, the Asian Development Bank, and in the private sector as Japan economist for Credit Suisse. He received a PhD in economics from the University of Wisconsin–Madison in 1996.

Abbreviations

2SLS ADF

two-stage least squares augmented Dickey–Fuller

ALMD

Assets and Liabilities Management Division

ARA

Adequacy of Reserves Accumulation

AREAER

Annual Report on Exchange Arrangements and Exchange Restrictions

BCCR

Central Bank of Costa Rica

BCDs

Central Bank of Chile dollar-denominated bond

BCU

Banco Central del Uruguay

BIS

Bank for International Settlements

Ch

Chilean

CIP

covered interest parity

CPI

consumer price index

CSR

cost of the surplus reserves

CUE

continuously updated estimator

DIR

direct intervention

DUS

trade-weighted nominal exchange rate index for the United States

ECB

European Central Bank

EGARCH

exponential generalized autoregressive conditional heteroskedasticity

EMBI

Emerging Markets Bonds Index

FRED

Federal Reserve

FX Commission

Foreign Exchange Commission

G3

Group of Three

GARCH

generalized autoregressive conditional heteroskedasticity

GC

gobierno central (central government)

GDP

gross domestic product

IBR

inter-bank rate

INDIR

indirect intervention

IRFs

impulse-response functions

ITLUP

Uruguayan peso-nominated yield curve

IV

instrumental variable

LA5

Latin America 5

M1

Monetary Target

MONEX

Mercado de Monedas Extranjeras

MXN

Mexican peso

NBER

National Bureau of Economic Research

NDFs

nondeliverable forwards

NFXP

net foreign exchange purchases

NSSc

nonstatistically significant results

OECD

Organisation for Economic Co-operation and Development

OLS

ordinary least squares

PEMEX

Petróleos Mexicanos

RECOPE

Refinadora Costarricense de Petróleo

S.D.

standard deviation

S.E.

standard error

SC BCRP

Swaps Cambiarios del Banco Central de Reserva del Pe r ú

SDRs

Special Drawing Rights

SELIC

Sistema Especial de Liquidação e Custo

SELIC

Sistema Especial de Liquidaçãoe Custo system

SR

surplus reserves

STER

sterilized

SVAR

structural vector autoregression

TES

títulos de tesorería (Treasury bills in Colombia)

TRM

tasa de cambio representativa del mercado (representative market exchange rate)

UIP

uncovered interest parity

USD

US dollar

UY peso

Uruguayan peso

VAR

vector autoregression

VIX

Volatility Index

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