Foreign exchange intervention and financial stability

Agénor, Pierre-Richard ORCID: 0000-0001-5720-3544, Jackson, Timothy P ORCID: 0000-0002-6142-8882 and Pereira da Silva, Luiz A (2026) Foreign exchange intervention and financial stability Journal of International Money and Finance, 160. p. 103439. ISSN 0261-5606, 1873-0639

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Abstract

The effects of sterilized intervention are studied in a model with financial frictions. The central bank operates a managed float and issues sterilization bonds. In contrast with most of the existing literature, these bonds are held only by banks, and are imperfect substitutes for loans. The model is parameterized and used to study optimal policy responses to capital inflows associated with a transitory shock to world interest rates. The results show that sterilized intervention can be expansionary due to a bank portfolio channel and may exacerbate risks to financial stability. Full sterilization is optimal only when that channel is absent. The optimal degree of intervention is more aggressive when the central bank can choose simultaneously the degree of sterilization; in that sense, and conditional on intervention taking place, the instruments are complements. When the central bank's objective function also accounts for the implicit cost of sterilization, and concerns with that cost are sufficiently high, intervention and sterilization can be substitutes—independently of whether exchange rate and financial stability considerations also matter for policymakers.

Item Type:	Article
Uncontrolled Keywords:	3801 Applied Economics, 3802 Econometrics, 3803 Economic Theory, 35 Commerce, Management, Tourism and Services, 38 Economics, 3502 Banking, Finance and Investment
Divisions:	Faculty of Humanities & Social Sciences Faculty of Humanities & Social Sciences > School of Management
Depositing User:	Symplectic Admin
Date Deposited:	26 Sep 2025 09:48
Last Modified:	14 Jan 2026 09:22
DOI:	10.1016/j.jimonfin.2025.103439
Related Websites:	Publisher
URI:	https://livrepository.liverpool.ac.uk/id/eprint/3194611
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