Foreign exchange intervention: how to signal policy objectives and stabilise the economy

Abstract Within a simple model of monetary policy for an open economy, we study how foreign exchange intervention may be used as a costly signal of the policy makers’ objectives. Our analysis indicates that: (i) foreign exchange intervention typically stabilises the national economy, reducing the fluctuations of employment and output; (ii) this result is sensitive to the institutional structure of decision-making, in that a larger stability gain is obtained when foreign exchange intervention and monetary policy are kept under the jurisdiction of different governmental agencies.

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