Foreign exchange intervention and macroeconomic stability

Using a standard monetary policy model, we study how foreign exchange intervention may be used to condition the perception among economic agents of the objective of the policymaker. Foreign exchange intervention does not bring about a systematic policy again, such as an increase in the equilibrium level of employment or a reduction in the inflationary bias. However, it can stabilise the economy, for it drastically reduces the fluctuations of real variables such as the output and employment levels. This stability gain is obtained at the cost of greater volatility of nominal variables, such as the nominal wage, the price level and the exchange rate. We also find that sterilised intervention is generally profitable. Finally, our analysis outlines a trade-off between the profits the central bank gains and the stability gain sterilised intervention brings about.