Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience

This paper discusses the role of foreign exchange interventions in the inflation-targeting regime, focusing on the Czech experience since 1998. It proposes criteria for assessing whether the interventions are consistent with the inflation targeting. While the CNB's interventions in mid- 1998 and in 2002 pass these criteria easily, the judgement might be more uncertain concerning the interventions in early-1998 and in 1999/2000. It is also stressed that the literature on managed floating usually ignores the difficulty in defining clear procedural rules for the interventions. This contrasts with the procedures guiding the interest rate decisions under the inflation targeting regime, which may occasionally create tensions in the policy regime, as demonstrated by the Czech experience, too. The interventions' effectiveness in the Czech Republic is also discussed. It seems that sometimes they might have had an immediate impact lasting up to 2 or 3 months, but no strategy can be identified that would work in all episodes. Moreover, even many of the 'successful' interventions were not able to prevent quite prolonged periods of exchange rate overvaluation in 1998 and in 2002. It is concluded that the signalling role of foreign exchange interventions is more important than their 'market-equilibrating effect', implying a rather unstable transmission between the central bank actions and the market reactions. Finally, the paper analyses the sterilisation costs, which are shown to have been quite substantial in the Czech Republic. It is argued that the financial sustainability of the interventions is quite important for their credibility and effectiveness.Exchange rate, foreign exchange interventions, inflation targeting, sterilisation.

Foreign exchange interventions under inflation targeting: the Czech Experience

This paper discusses the role of foreign exchange interventions in the inflation-targeting regime, focusing on the Czech experience since 1998. It concludes that the case for foreign exchange interventions is not clear in an inflation targeting regime both from the theoretical and empirical point of view. First, the stylised facts on the effectiveness of Czech interventions suggest that sometimes these might have had an effect lasting up to 2 or 3 months, but no strategy can be identified that would work in all episodes. Moreover, even many of the "successful" interventions were not able to prevent quite prolonged periods of exchange rate overvaluation in 1998 and in 2002. Second, the sterilisation costs of interventions are shown to have been quite substantial in the Czech Republic, which had in certain period affected their credibility and effectiveness. Third and most importantly, the interventions may lead to tensions with the philosophy of the inflation targeting regimes on the procedural and communication level, which might have a negative impact on the credibility of the policy regime. The paper proposes some criteria for assessing whether the interventions are not in a conflict with the inflation targeting regime, and applies these criteria to the Czech case. From an ex post view, all the intervention episodes are judged to be consistent with the inflation targets and output developments, but there may be some doubt in other respects concerning the intervention episodes in early-1998 and late-1999. --Exchange rate,foreign exchange interventions,inflation targeting,sterilisation