Full Description
Foreign exchange intervention is frequently being used by central banks in countries which have a floating exchange rate. Most theoretical monetary policy models, however, do not take this phenomenon into account. This book contributes to close this gap between theory and practice by interpreting foreign exchange intervention as an additional monetary policy instrument for inflation targeting central banks. In-depth empirical analyses of the foreign exchange operations and interest rate policy of five inflation targeting countries (Australia, Canada, New Zealand, Sweden and the United Kingdom) demonstrate how foreign exchange intervention is used in practice.
Table of Contents
1 Introduction 1 (6)
1.1 Background 1 (2)
1.2 Approach to the Problem and Research 3 (3)
Strategy
1.3 Structure of the Analysis 6 (1)
2 The Conventional View on Inflation Targeting 7 (26)
2.1 Definition and Elements of Inflation 7 (10)
Targeting
2.1.1 Lack of an Explicit Intermediate 8 (4)
Target
2.1.2 Price Stability as the Final Target 12 (1)
2.1.3 Publication of a Numerical Target 13 (2)
2.1.4 Transparent Communication of Central 15 (1)
Bank Decisions
2.1.5 Increased Accountability of the 16 (1)
Central Bank
2.1.6 Summary and Assessment 16 (1)
2.2 Adoption of Inflation Targeting 17 (4)
2.2.1 Overview 17 (1)
2.2.2 Country Selection 18 (3)
2.3 A Basic Model for (Closed-Economy) 21 (2)
Inflation Targeting
2.4 Open Economy Inflation Targeting 23 (10)
2.4.1 Exchange Rate Pass-Through and 24 (3)
Monetary Policy
2.4.2 The Svensson Model 27 (1)
2.4.3 The Ball Model 28 (2)
2.4.4 Two Critical Assumptions 30 (3)
3 Uncovered Interest Parity in Practice 33 (12)
3.1 The Rationale of Interest Parity 33 (3)
3.1.1 Covered Interest Parity 33 (1)
3.1.2 Uncovered Interest Parity 34 (2)
3.2 An Empirical Test for Inflation Targeting 36 (6)
Countries
3.3 Consequences of the Failure of UIP 42 (3)
4 Sterilised Interventions as an Additional 45 (34)
Policy Instrument
4.1 Explaining and Interpreting Sterilised 45 (14)
Interventions
4.1.1 Channels for Influencing Exchange 45 (3)
Rates
4.1.2 Sterilised Interventions as a 48 (4)
Monetary Policy Instrument
4.1.3 Sterilisation Evidence for Inflation 52 (2)
Targeting Countries
4.1.4 Managed Floating in Theory 54 (4)
4.1.5 Limitations of Sterilised 58 (1)
Interventions
4.2 The Effectiveness of Sterilised 59 (20)
Interventions: A Review of the Literature
4.2.1 The Intervention Debate 59 (2)
4.2.2 The Inefficiency of Sterilised 61 (1)
Interventions in Monetary Models
4.2.3 The Portfolio Balance Channel of 62 (2)
Interventions
4.2.4 Interventions as a Signal of Future 64 (4)
Monetary Policy
4.2.5 Noise-Traders and the Role of 68 (3)
Sterilised Interventions
4.2.6 The Microstructure Approach and 71 (5)
Sterilised Interventions
4.2.7 Assessment of Intervention Models 76 (3)
5 Sterilised Foreign Exchange Intervention in 79 (66)
Practice
5.1 Foreign Exchange Reserves as an 80 (13)
Intervention Proxy
5.1.1 Reasons for Holding Foreign Exchange 82 (2)
Reserves
5.1.2 Mechanics of Foreign Exchange 84 (3)
Intervention
5.1.3 External Influences on Foreign 87 (2)
Exchange Reserves and Their Adjustment
5.1.3.1 Identification and Correction of 87 (1)
Valuation Effects
5.1.3.2 Estimation of Interest Earnings 88 (1)
5.1.4 The Correlation between Official 89 (2)
Interventions and Reserves
5.1.5 Active versus Passive Interventions 91 (2)
5.2 Intervention Activity in Inflation 93 (14)
Targeting Countries
5.2.1 Comparison of Intervention Capacities 93 (2)
5.2.2 Comparison of Reserve Changes 95 (2)
5.2.2.1 Correction for Valuation Changes 95 (1)
5.2.2.2 Correction for Interest Earnings 96 (1)
5.2.3 Identification of Intervention 97 (4)
Activity
5.2.3.1 Absolute Reserve Changes 98 (1)
5.2.3.2 Normalisation with the Degree of 98 (1)
Openness
5.2.3.3 Normalisation with the Size of 99 (1)
Foreign Exchange Markets
5.2.3.4 Response to Shocks 100(1)
5.2.4 Ranking of Intervention Activity 101(6)
5.3 The Use of Interventions as an Additional 107(15)
Policy Instrument
5.3.1 Interventions and the Variation of 109(3)
Interest Rates
5.3.1.1 Interest Rate Volatility Compared 109(1)
5.3.1.2 Frequency of Policy Rate Changes 110(1)
Compared
5.3.1.3 Interpretation of the Findings 111(1)
5.3.2 Policy Reaction Functions and 112(10)
Exchange Rates
5.3.2.1 Evolution of Taylor Rules 112(2)
5.3.2.2 Description of Data and Methods 114(2)
5.3.2.3 Stationarity Tests 116(1)
5.3.2.4 Country-Specific Results and 117(5)
Interpretation
5.4 Short Case Studies of the Country 122(23)
Experiences
5.4.1 New Zealand 123(4)
5.4.2 Canada 127(4)
5.4.3 Australia 131(4)
5.4.4 United Kingdom 135(5)
5.4.5 Sweden 140(5)
6 Performance of Inflation Targeting: An 145(6)
Evaluation
7 Conclusion and Outlook 151(4)
Appendix 155(8)
List of Figures 163(2)
List of Tables 165(2)
Bibliography 167
