Causes and Consequences of Emerging Market Central Banks' Long-Term Foreign Exchange Exposure

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The paper analyzes how central banks pay attention to foreign exchange exposure and the profit function in pursuing monetary policy. The results of the paper document that in practice, central banks do not take the microeconomic approach based on profit maximization in making decisions on the level of foreign exchange reserves or the magnitude of the open foreign exchange position. According to the authors' estimations, only the interest rate differential plays a role in central banks' decisions. Central banks do not seem to take into account in their foreign exchange interventions any possible negative impacts on the profit and loss statement that may result from an adverse exchange rate trend, the costs of sterilizing foreign exchange interventions, or high exchange rate volatility.