Transcript Comments on “Can Foreign Exchange Intervention Stem Exchange Rate Pressures from Global Capital Flow Shocks?” by Olivier Blanchard, Gustavo Adler & Irineu de Carvalho.

Comments on “Can Foreign Exchange
Intervention Stem Exchange Rate Pressures
from Global Capital Flow Shocks?”
by Olivier Blanchard, Gustavo Adler
& Irineu de Carvalho Filho
Jeff Frankel
Harvard Kennedy School
At NBER Summer Institute, IFM, July 6, 2015
• The sort of paper that I wish I had written.
• Why the question is important:
– True, most big advanced countries don’t intervene in the
foreign exchange market these days,
• as they did as recently as the 1990s.
• The G-7 in 2013 even agreed to refrain from intervention, out of
fears regarding “currency manipulation” and “currency wars.”
– But major EM countries do intervene,
• having switched to managed floating from exchange rate targets,
after the crashes of the 1994-2002.
– It is useful to figure out if intervention works
• as an additional tool, at least partly independent of monetary policy:
• for thinking about current EM options
– when coping with inflows,
– or their reversal.
• Further, it might also be useful for thinking about the big countries,
when, someday, some start intervening again.
Empirical approach
• The two alternative approaches they mention,
indeed have the problems they mention:
– The endogeneity of intervention with respect to the
exchange rate masks effects of intervention.
– High-frequency data can help address endogeneity,
but don’t tell us if the intervention effect lasts long.
• The authors' empirical approach:
– In response to capital inflow episodes, did those
countries that intervened more (buying fx) experience
less currency appreciation?
Findings
• First: an increase in global risk appetite leads to
appreciation of inflow-receiving currencies,
– and an increase in gross capital inflows;
– but also an increase in gross capital outflows.
• This is not consistent with a view of gross capital outflows
as a component of the net capital flow or current account.
• The interpretation here is that “risk off” means everyone pulls
back to their own countries, not necessarily to safe havens;
“risk on” means they venture forth.
• That is consistent with home bias,
– E.g., because different consumption baskets => different home bases.
• But I find it surprising if the US is treated as a safe haven only
by US investors and not by EM investors.
Findings, continued
• Main finding: exogenous capital inflows lead to
smaller currency appreciations in those countries
that intervene than those that don’t.
– As one might expect:
» “consistent with the portfolio balance channel.”
– So intervention is effective.
“Portfolio Balance” terminology
• In the language of research in the 1980s & early
1990s, the PB channel was one of two possible
channels through which (sterilized) fx intervention
could have effects.
– The other was the expectations channel,
• or more specifically the “signaling” channel.
– I used this language as much as anybody.
– And I am happy to see the recent revival of the portfolio
balance model in general in recent years,
• e.g., to think about effects of debt, current accounts, & Unconventional Monetary Policy.
– Nonetheless, I am not sure the language is quite right here.
“Portfolio Balance” terminology, continued
• 20 or 30 years ago was a time when it was taken for granted
that capital mobility had become “perfect “ among the
countries in question (industrialized countries)
• in the specific sense of no capital controls or transactions costs
• and as reflected in equalization of interest rates (controlling for risk),
» for example, in Covered Interest Parity.
• The portfolio balance model allowed for imperfect
substitutability across assets,
– but it differed from the earlier Mundell-Fleming model in that
the differential in returns was now related to the stock of assets,
rather than the flow.
• The Blanchard-Adler-de-Carvalho-Filho paper is about flows.
“Portfolio Balance” terminology, continued
• Further, 30 years ago the money supply was usually treated
as the proper measure of monetary policy,
– consistent with the tenets of Milton Friedman’s monetarism.
– But after monetarism crashed and burned in the 1980s, we went back
to considering the interest rate as the measure of monetary policy.
– More recently, the proposition that doubling money doubles the price
level, once universally accepted, doesn’t seem to fit the facts,
• at least not within a 10-year horizon.
– So it may be anachronistic to assume that the alternative channel
involves signaling future increases in money.
– Further, since the advent of QE and other “Unconventional Monetary
Policies” we have come to accept that central banks can probably have
effects by changing the composition of their balance sheets,
• leaving aside the total level of the monetary base,
• e.g., as effects on the term structure from changing the composition between
short-term versus long-term assets,
• If that is true, it follows that they can have effects by sterilized fx intervention,
– which changes the composition of the central bank’s balance sheet between
domestic & foreign assets without changing the total monetary base.
“Gross inflows” and “gross outflows”*
• defined as net Δ international liabilities and assets, respectively.
– The idea is that the gross inflows = deliberate decisions by foreign residents
– and gross outflows = deliberate decisions by domestic residents.
• Yes, some good recent papers have used gross flows [fn 3],
• But I still have some hesitation about the use of gross data.
– It takes two to make a transaction, one in each country.
– Examples:
• If an EM bank borrows from an Advanced Country bank, is that a
positive gross capital inflow, or a negative gross capital outflow?
• If a firm repurchases its stock from investors, some of them
abroad, which is that?
• Could the authors do a similar exercise with net capital flows,
– measured either as gross capital inflows minus gross inflows,
– or as the current account deficit minus fx intervention?
• A motive for looking at the current account measure: the statistical discrepancy
is usually thought to be mostly unmeasured capital flows.
Classifying interveners vs. floaters
• Among countries with flexible exchange rate regimes,
the authors classify countries as interveners those
that responded to global capital flow episodes with
larger intervention (relative to GDP), and as floaters
those with less.
• Question: What if more capital flows go into some
countries than others, and so the classification
criterion partly reflects the magnitude of exchange
market pressure, not just the propensity to respond to
the pressure with intervention?
The case of Latin America in 2010
Inflows were reflected more as reserve accumulation in Peru,
but more as appreciation in Chile & Colombia.
more-managed floating
less-managed floating
Source: GS Global ECS Research
Inference: Chile & Colombia are floaters, Peru is an intervener. Okay.
The case of Asia in 2010
Korea & Singapore took inflows mostly in the form of reserves,
while India & Malaysia took them more as currency appreciation.
more-managed floating
less-managed
floating
Source: GS Global ECS Research
Inference: Thailand intervenes more than Indonesia or Hong Kong?
Goldman
Sachs Globalin
ECS
Research
But it may be an artefact of more exchange market
pressure
Thailand.
An alternative measure of propensity to intervene.
• Perhaps interveners should be classified as those with
larger intervention relative to total Exchange Market
Pressure:
– Propensity to intervene ≡ (Intervention/MB) / EMP
• where EMP ≡ (Intervention/MB) + Δ log Exchange Rate.
– In the spirit of Calvo & Reinhart (2002)
– and Levy Yeyati & Sturzenegger (2005).
• But this might pre-cook the result that more
intervention is associated with less appreciation.
– The problem is that EMP is not exogenous.
Two possibly useful follow-on exercises
• An alternative to using a global capital flows as the exogenous
experiment: one could use global commodity prices,
– tailored to the commodity trade mix of the country in question.
– To what extent do those oil exporters that intervene more
heavily in the forex market succeed in dampening exchange rate
changes that result from oil price fluctuations?
• Page 16 talks about another useful extension -An alternative to looking at effects on the nominal exchange rate:
what about effects on the real exchange rate?
– I didn’t see in the results reported there a clear test of whether
intervention does or doesn’t dampen real appreciation.
– The effect of intervention is less important if the suppression
of nominal appreciation just means more inflows that show up
as inflation, with the same effect on the real exchange rate.