Managing Capital Outflows with Limited Reserves

We analyze the optimal intervention policy for an emerging market central bank that wishes to stabilize the exchange rate during a capital outflow episode, but possesses limited reserves. We show that adding a non-negativity constraint on reserves onto a simple linear-quadratic framework generates a...

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Bibliographic Details
Published inIMF economic review Vol. 66; no. 2; pp. 333 - 374
Main Authors Basu, Suman S., Ghosh, Atish R., Ostry, Jonathan D., Winant, Pablo E.
Format Journal Article
LanguageEnglish
Published London Palgrave Macmillan Journals 01.06.2018
Palgrave Macmillan UK
Palgrave Macmillan Ltd. (Springer)
Palgrave Macmillan
Subjects
Analysis
Bank reserves
Capital Markets
Capital movement
Central banks
Depreciation
Economic aspects
Economic models
Economic Policy
Economics
Economics and Finance
Emerging markets
Fiscal policy
Foreign exchange rates
International Economics
Intervention
Macroeconomics/Monetary Economics//Financial Economics
Management
RESEARCH ARTICLE
E44
F32
F31
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Summary:We analyze the optimal intervention policy for an emerging market central bank that wishes to stabilize the exchange rate during a capital outflow episode, but possesses limited reserves. We show that adding a non-negativity constraint on reserves onto a simple linear-quadratic framework generates a time consistency problem. A central bank with full commitment achieves a gradual depreciation to the pure-float level by promising sustained future intervention, such that reserves are exhausted after particularly adverse shocks. A central bank without commitment intervenes little, wishing to preserve some reserves forever, so it suffers a larger immediate depreciation and achieves lower welfare. For more persistent shocks, the time consistency problem is greater, and simple intervention rules can achieve welfare gains relative to discretion.
ISSN:2041-4161
2041-417X
DOI:10.1057/s41308-018-0055-7