Working Paper: NBER ID: w1289
Authors: Stephen J. Turnovsky
Abstract: This paper analyzes exchange market intervention in a stochastic model of a small open economy. The distinction is made between disturbances which are unanticipated and anticipated on the one hand, and those that are perceived as being transitory or permanent, on the other. The paper demonstrates how the appropriate form of exchange market intervention is sensitive to these aspects of the disturbances. Of particular interest is the case of an unanticipated permanent disturbance, when output may be stabilized perfectly about its frictionless level by the use of a very simple class of intervention rules.The optimal rules in other cases are also discussed.
Keywords: exchange market intervention; stochastic model; small open economy; exogenous disturbances
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Unanticipated disturbances perceived as transitory (E32) | challenges in stabilizing output (E63) |
| Optimal intervention policy (C61) | influenced by variances of domestic stochastic disturbances (C22) |
| Unanticipated permanent disturbances (Q54) | output can be perfectly stabilized (C62) |
| Appropriate intervention rules (L00) | output stability (E23) |
| Anticipated disturbances (D84) | affects expected exchange rate (F31) |
| Expected exchange rate (F31) | influences output stabilization (E63) |
| Disturbances perceived as transitory or permanent (E32) | perfect stabilization of output (C62) |