ESSAYS ON FOREIGN EXCHANGE INTERVENTION

The Indonesian experience with foreign exchange intervention (FXI) is of interest. Since the adoption of inflation targeting in 2005, Bank Indonesia (BI) uses FXI as an integral part of its policy mix. Consequently, unlike many emerging market economies, BI intervenes in the exchange rate market more frequently. Using Indonesian experience with FX intervention, this research aims to provide insights into several key issues: How effective are foreign exchange interventions? Indeed, do they work at all? If so, what determines the effectiveness? How much should a central bank intervene and when? Finally, what are the effects of interventions on macroeconomic conditions? My dissertation focuses on these questions and divides into two chapters.
The first chapter reconciles different results found in the literature regarding the effect of foreign exchange interventions. Using a simple FX intervention rule and a Bayesian vector autoregressions (VAR) model estimated on Indonesian data, I find that the heterogeneity can, to a large extent, be traced back to differences in the identification of the policy shock in the VAR model. I show that different identification approaches correspond to different magnitude of interventions which lead to different effects. Lastly, this chapter provides operational insights on how to conduct FX interventions that are deemed effective.
In the second chapter, I conduct an empirical exercise that aims to give understanding on how sterilized foreign exchange intervention affects domestic credit. Conceptually, an important element of this exercise is the direct effect of Bank Indonesia's attempt to sterilize its foreign reserve transactions on commercial banks' balance sheet composition. I find that the sterilization of foreign reserve purchases crowd-out bank lending. Such impacts, however, depend on bank-level characteristics.