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Foreign exchange intervention and inflation targeting: The role of credibility
(with Ruy Lama and Juan Pablo Medina) 
Journal of Economic Dynamics and Control (forthcoming)

We develop a small open economy model where the central bank operates under a flexible inflation targeting regime, i.e., monetary policy is aimed at stabilizing output and inflation. In this theoretical framework, we analyze to what extent foreign exchange intervention (FXI) can contribute to the central bank goals for different degrees of credibility. We find two key results. First, in a baseline scenario where the central bank is perfectly credible, FXI can improve macroeconomic outcomes by successfully stabilizing both output and inflation in response to foreign disturbances. Second, when central bank lacks credibility, FXI policies entail a trade-off by reducing output volatility at the expense of inducing higher inflation volatility. In this scenario, FXI policies prevent the central bank from achieving the goal of price stability. These results suggest that FXI is more likely to support an inflation targeting regime when the credibility of the central bank is high.


The Measurement of External Accounts

(with Daniel Garcia-Macia and Signe Krogstrup)
IMF Working Papers No. 19/132, 2019

Growing international integration in trade and finance can challenge the measurement of external accounts. This paper presents a unified conceptual framework for identifying sources of mismeasurement of foreign investment income in current account balances. The framework allows to derive a precise definition of measurement distortions and an empirical strategy for estimating their importance. As an application, we empirically estimate two specific distortions related to inflation and retained earnings on portfolio equity for a broad set of countries. We find these may explain a non-trivial share of current account imbalances and that they are particularly relevant in countries with large external investment positions. We also discuss how merchanting and profit-shifting activities could lead to measurement distortions. We suggest areas for future research and underline the need to strengthen data collection efforts.

The External Balance Assessment Methodology: 2018 Update 
(with L. Cubeddu; S. Krogstrup; P. Rabanal; M. Dao; S. Hannan; L. Juvenal; C. Osorio Buitron; C. Rebillard; D. Garcia-Macia; C. Jones; J. Rodriguez; K. Chang; D. Gautam; Z. Wang; N. Li.)
IMF Working Papers No. 19/65, 2019

The assessment of external positions and exchange rates is a key mandate of the IMF. This paper presents the updated External Balance Assessment (EBA) framework—a key input in the conduct of multilaterally-consistent external sector assessments of 49 advanced and emerging market economies—following the two rounds of refinements adopted since the framework was introduced in 2012 (as described in Phillips et al., 2013). It also presents new complementary tools for shedding light on the role of structural factors in explaining external imbalances and assessing potential biases in the measurement of external positions. Remaining challenges and areas of future work are also discussed.


Unveiling the Effects of Foreign Exchange Intervention; A Panel Approach
(with Noemie Lisack and Rui Mano)
Emerging Markets Review, June 2019
IMF Working Papers 15/130, 2015

The paper studies the effect of foreign exchange intervention on the level of the exchange rate relying on an instrumental-variable panel approach suited to assess the macroeconomic importance of such effect (i.e., beyond short-term effects found in the literature). We find robust evidence that intervention affects the exchange rate in a meaningful way from a macroeconomic perspective. A purchase of foreign currency of 1 percentage point of GDP causes a depreciation of the nominal and real exchange rates in the ranges of [1.7–2.0] percent and [1.4–1.7] percent, respectively. The effects are found to be persistent and symmetric for FX purchases and sales.

Monetary Policy and the US Trade Balance
(with Carolina Osorio Buitron) 
International Finance, December 2018
IMF Working Paper 17/204, 2017

The strong policy response of the United States to the 2008–2009 financial crisis raised concerns about its spillovers on other countries. The effects of the monetary stimulus received significant attention, while those of fiscal policy were largely overlooked, despite the combined deployment of these two policy instruments. This paper studies the trade spillovers of the post‐crisis policy mix. We find that overall effects were positive in the immediate aftermath of the crisis, reflecting positive spillovers of fiscal policy that outweighed the negative impact of monetary policy. More generally, our results highlight (i) the importance of studying fiscal and monetary policy spillovers jointly, as models with both instruments produce very different (and arguably more accurate) estimates of the effects of fiscal and monetary policy shocks, and (ii) that exchange rate regimes of trading partners are first‐order determinants of the extent of policy spillovers.

The Cost of Foreign Exchange Intervention: Concepts and Measurement
(with Rui Mano)
Journal of Macroeconomics, August, 2018
IMF Working Papers 16/89, 2016

Foreign exchange intervention led to a sizable expansion of many central banks’ balance sheets over the last decade, raising questions about the associated fiscal costs. This paper clarifies conceptual issues about how to measure these costs both from an ex-post and an ex-ante (relevant for decision making) perspective and estimates both marginal and total costs for 73 countries over the period 2002-13. Averaging across various estimation methods, we find ex-ante marginal costs in the inter-quartile range of 2.0-5.5 percent per year for emerging market economies. Reflecting differences in the accumulation of foreign exchange, ex-ante total costs amounted to 0.2-0.7 percent of GDP per year in countries with limited intervention, while reaching 0.3-1.2 percent of GDP per year in heavy-intervening economies. These estimates indicate that fiscal costs of sustained FX intervention are not negligible.

The Stabilizing Role of Net Foreign Asset Returns 
(with Daniel Garcia-Macia)
IMF Working Paper 18/79, 2018

With the rapid growth of countries' foreign asset and liability positions over the last two decades, financial returns on those positions ('NFA returns') have become material drivers of current accounts and net stock positions. This paper documents the relative importance of NFA return versus trade channels in driving NFA dynamics, for a sample of 52 economies over 1990-2015. While persistent trade imbalances have been a strong force leading to diverging NFA positions, NFA returns have played an important stabilizing role, mitigating NFA divergence. The stabilizing role of NFA returns primarily reflects the response of asset prices, rather than yield differentials or exchange rates. There is also evidence of heterogeneity in the speed of NFA adjustment, with emerging market economies adjusting more rapidly than advanced economies, and reserve-currency countries adjusting more slowly than others. The paper also documents the role of NFA returns as insurance against domestic and global income shocks, with a focus on reserve-currency countries.


Unconventional Policies and Exchange Rate Dynamics
 (with Ruy Lama and Juan Pablo Medina Guzman)
Journal of International Money and Finance, 2018
Working Paper No. 17/237

We study exchange rate dynamics under cooperative and self-oriented policies in a two-country DSGE model with unconventional monetary and exchange rate policies. The cooperative solution features a large exchange rate adjustment that cushions the impact of negative shocks and a moderate use of unconventional policy instruments. Self-oriented policies (Nash equilibrium), however, entail limited exchange rate movements and an aggressive use of unconventional policies in both countries. Our results suggest that sizable exchange rate depreciations are not always a symptom of “beggar-thy-neighbor” policies. They could also reflect a desirable process of external adjustment that improves global welfare.

Tipping the Scale: The Working of Monetary Policy through Trade
(with Carolina Osorio Buitron)
IMF Working Paper 17/142, 2017

Monetary policy entails demand augmenting and demand diverting effects, with its impact on the trade balance—and spillovers to other countries—depending on the relative magnitude of these opposing effects. Using US data, and a sign-restricted structural VAR identification strategy, we investigate how monetary policy shocks affects the trade balance, shedding light on the importance of the two effects. Overall, the results indicate that monetary policy has a meaningful impact on the trade balance. A monetary loosening (tightening) leads to a strengthening (weakening) of the overall trade balance, indicating that, on average, demand diversion dominates. This effect of monetary policy on trade is revealed in full when distinguishing between trading partners with fixed exchange rates—for which only demand augmenting operates—and flexible exchange rates—for which both effects operate. We also explore spillover differences between conventional and unconventional monetary policy, as well as changes in spillovers in the postcrisis period (due to an impaired monetary transmission mechanism). While our results suggest that monetary policy comes with spillovers through trade, they should not be interpreted as evidence against the use of this policy instrument as such. From a global perspective, optimal monetary policy should be assessed in conjunction with deployment of other policy measures, including the ability of recipient countries to deploy their own policy measures to offset undesirable spillovers.

Gone with the Headwinds; Global Productivity
(with R. A. Duval, D. Furceri, S. Kılıç Çelik, K. Koloskova and M. Poplawski-Ribeiro)
IMF Staff Discussion Notes 17/04, 2017

Productivity growth—the key driver of living standards—fell sharply following the global financial crisis and has remained sluggish since, adding to a slowdown already in train before. Building on new research, this note finds that the productivity slowdown reflects both crisis legacies and structural headwinds. In advanced economies, the global financial crisis has led to “productivity hysteresis”—persistent productivity losses from a seemingly temporary shock. Behind this are balance sheet vulnerabilities, protracted weak demand and elevated uncertainty, which jointly triggered an adverse feedback loop of weak investment, weak productivity and bleak income prospects. Structural headwinds—already blowing before the crisis—include a waning ICT boom and slowing technology diffusion, partly reflecting an aging workforce, slowing global trade and weaker human capital accumulation. Reviving productivity growth requires addressing remaining crisis legacies in the short run while pressing ahead with structural reforms to tackle longer-term headwinds.

Foreign Exchange Intervention under Policy Uncertainty
(with Ruy Lama and Juan Pablo Medina Guzman)
IMF Working Paper 16/67, 2016

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.

Can Foreign Exchange Intervention Stem Exchange Rate Pressures from Global Capital Flow Shocks?
(with Olivier Blanchard and Irineu de Carvalho Filho). 
NBER Working Papers 21427; PIIE Working Paper Series WP15-18; IMF WP 15/159

Many emerging market economies have relied on foreign exchange intervention (FXI) in response to gross capital inflows. In this paper, we study whether FXI has been an effective tool to dampen the effects of these inflows on the exchange rate. To deal with endogeneity issues, we look at the response of different countries to plausibly exogenous gross inflows, and explore the cross country variation of FXI and exchange rate responses. Consistent with the portfolio balance channel, we find that larger FXI leads to less exchange rate appreciation in response to gross inflows.

Does Central Bank Capital Matter for Monetary Policy?
(with Camilo E. Tovar Mora and Pedro Castro)
Open Economies Review, Springer, vol. 27(1), pages 183-205, February 2016

This paper examines empirically whether central bank capital influences the conduct of monetary policy. To this end, we estimate interest rate rules for a sample of 41 countries and employ linear and non-linear regression methods to test if a measure of central bank financial strength can explain deviations of actual interest rates from those predicted by the estimated interest rate (Taylor-like) rules. Our results suggest that central bank capital is indeed a relevant factor behind interest rate policy decisions.

Global Financial Shocks and Foreign Asset Repatriation; Do Local Investors Play a Stabilizing Role?
(with Marie-Louise Djigbenou and Sebastian Sosa)
Journal of International Money and Finance, Elsevier, vol. 60(C), pages 8-28, 2016.

We study the dynamic response of gross capital flows in emerging market economies to different global financial shocks, using a panel vector-autoregressive (PVAR) approach. Our focus lies primarily on the potentially stabilizing role played by domestic investors in offsetting the response of foreign investors to adverse global shocks. We find that, while foreign investors tend to retrench from emerging markets in response to global risk aversion and monetary policy shocks, foreign asset repatriation by resident investors does not always follow suit. Local investors play a meaningful stabilizing role in the face of global risk aversion shocks, with sizeable asset repatriation largely offsetting the retrenchment of non-residents. In contrast, foreign investor retrenchment in response to global monetary policy shocks is not mirrored by asset repatriation. Finally, we find robust evidence that positive global real shocks tend to have a positive impact on net capital inflows to emerging markets. Our results shed light on the likely impact of the Fed's QE tapering on capital flows to emerging market economies.


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