Abstract
We study the use of foreign exchange (FX) intervention as an additional policy instrument in anenvironment with learning, where agents infer the central bank policy rules from its policy actions.Under full information, a central bank focused on stabilizing output and inflation can achievebetter outcomes by using FX intervention as an additional policy tool. Under policy uncertainty,where agents perceive that monetary policy may also have exchange rate stabilization goals, theuse of FX intervention entails a trade-off, reducing output volatility while increasing inflationvolatility. While having an additional policy tool is always beneficial, we find that the optimalmagnitude of intervention is higher in monetary policy regimes with lower uncertainty. Theseresults indicate that the benefits of using FX intervention as an additional stabilization tool aregreater in regimes where monetary policy is credibly focused on output and inflation stabilization.
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