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Foreign Exchange Interventions under Inflation Targeting

Student: Anastasiia Suchkova

Supervisor: Andrey G. Shulgin

Faculty: Faculty of Economics

Educational Programme: Economics (Bachelor)

Year of Graduation: 2016

A growing number of countries adopted an inflation targeting (IT) framework, both developed economies and emerging markets. According to empirical evidence, this monetary policy regime is effective in terms of stabilizing both inflation and the real economy. However, the main question in conducting policy under IT concerns the appropriate response to exchange rate movements. For example, a number of researchers include the exchange rate in the central bank’s policy rule – Taylor rule. It is also proposed to employ foreign exchange (FX) interventions and interest rate policy simultaneously. The main purpose of this study is to evaluate the efficiency of the use of sterilized foreign exchange intervention under inflation targeting. To this end, we develop a New Keynesian dynamic stochastic general equilibrium model with two independent instruments. Independence of instruments in model is provided through risk premium rate. The model is calibrated for Russia. Furthermore, we generate the impulse-response functions to analyze the transmission mechanism of monetary policy. Then we calculate the coefficients in the monetary policy rules that minimize central bank losses. Finally, welfare analysis is provided. To this and, we summarize the macroeconomic volatility implied by the various rules in response to the shocks, which we focus on (oil price shock, productivity shock, markup shock), and calculate central bank losses. Given the above structure, we evaluate the performance of alternative policy rules and conclude that for the Russian economy the inflation targeting regime with two monetary rules is less effective than inflation targeting with one rule, which takes into account the exchange rate.

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