Economic disturbances and exchange market intervention policy

JaeHoon Youh, Purdue University

Abstract

This dissertation derives the different effects that non-sterilized direct intervention, sterilized direct intervention, and indirect intervention can have in a small open economy, and evaluates the appropriate intervention policy under different circumstances. In a dynamic model with the sticky price of domestic goods, exchange market intervention affects the short-run fluctuations of the economy and the speed of adjustment to the long-run equilibrium. When the substitutability of domestic and foreign bonds is finite, the effectiveness of each type of foreign exchange market intervention depends on the source of economic disturbances and the magnitude of the parameters. An appropriate intervention policy may be evaluated in terms of modifying the short-run impacts of a disturbance and changing the speed of adjustment of the economy. Any intervention policy can reduce a depreciation of the spot real exchange rate if the long-run real exchange rate is not higher than the depreciation spot rate. But in terms of dynamic adjustments to the long-run equilibrium, indirect intervention speeds up the adjustment and sterilized direct intervention slows down the adjustment. Non-sterilized direct intervention has an ambiguous effect, depending on the values of parameters. Therefore, in most cases considered, the dominant policy is indirect intervention as large as possible, because that minimizes the impact effect and speeds up the adjustment of the economy. When the same degree of intervention is used, non-sterilized direct intervention eliminates the impact effect the most. Therefore, if non-sterilized direct intervention speeds up the adjustment of the economy, and the purpose of the government is first to minimize the impact effect and second to speed up the adjustment of the economy, non-sterilized direct intervention is preferred. Also, in the case of increased domestic demand for domestic goods, sterilized direct intervention with $\mu$ $<$ 0 may speed up the adjustment of the economy and eliminate the impact effect, depending the magnitude of parameters, while other intervention policies enlarge the impact effect. Thus, the choice of an appropriate intervention policy depends on the source of economic disturbances, the values of parameters, and the priority of the government.

Degree

Ph.D.

Advisors

Carlson, Purdue University.

Subject Area

Economic theory

COinS