IMF Staff Backs Currency Intervention as a Policy Tool in Emerging Markets

Currency intervention is a valid instrument for central banks of emerging markets to use alongside interest rates, the International Monetary Fund staff said in a report.

Many developing economies have chosen to set an inflation target to anchor expectations after a history of price instability, according to the report. Openly adopting a second policy tool focused on managing exchange rates is likely to strengthen central banks’ credibility rather than undermine it, the IMF economists argue.

“The crisis has taught us that policy makers need to deliver more than stable consumer prices if they are to achieve sustained and stable growth, and that the instruments at their disposal include more than just the policy interest rate,” according to the report, whose authors include IMF Research Department Deputy Director Jonathan Ostry. For emerging markets “there are potentially two policy targets: inflation and the exchange rate.”

The report reflects recent efforts at the IMF to challenge macro-economic beliefs and adjust recommendations in the aftermath of the 2008 financial crisis, which the lender failed detect. The Washington-based IMF last year endorsed capital controls as part of the toolkit to manage inflows of money that threaten countries’ financial stability, marking a turn from its advice from crises in Latin America and Asia in the 1990s.

Exchange Rates

Brazil’s central bank earlier this month stepped up moves to contain the real’s appreciation and Colombia said it would resume purchases of dollars to ease a rally in the peso. The Bank of Thailand will let the market decide the exchange-rate of the baht and step in when needed, Deputy Governor Suchada Kirakul said today.

“Sometimes when there is excessive volatility, we could step in,” Suchada said, adding the bank intervened “a little bit” last week.

Actions by emerging markets’ policy makers suggest they believe they can influence exchange rates, Ostry said in a separate blog post.

“Policy makers in emerging markets countries are right to allow exchange rates objectives to enter into their decisions,” Ostry told journalists on a conference call today. Still they should make it clear they are choosing currency interventions as a tool “for words to be consistent with deeds,” he said.

“It’s much better to say that ‘we actually have two instruments so we will be able to do what is necessary to achieve our inflation target but we’re not going to let the exchange rate deviate in vast ways,’” he said.

Ignoring exchange rate volatility can be costly for emerging markets, according to the report.

If “a sudden surge in capital inflows leads to a large, temporary appreciation of the currency above its medium-term value, and that results in economic dislocation, then some intervention in the foreign exchange market is likely to be optimal,” even if there’s an inflation target, according to the report, whose authors also include Atish Ghosh and Marcos Chamon.

To contact the reporter on this story: Sandrine Rastello in Washington at srastello@bloomberg.net;

To contact the editor responsible for this story Christopher Wellisz at cwellisz@bloomberg.net

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