Magazine article Chicago Policy Review (Online)

Foreign Exchange Interventions: A Comparison of the Mexican and Brazilian Models

Magazine article Chicago Policy Review (Online)

Foreign Exchange Interventions: A Comparison of the Mexican and Brazilian Models

Article excerpt

Over the past several years, foreign exchange rates among Latin American countries have fluctuated significantly. These oscillations have been caused by several factors, including the U.S. presidential elections, changing oil prices, the Taper Tantrum (the expectation of a reduction in bond purchases by the Federal Reserve), interest rate hikes by the U.S. Federal Reserve, and idiosyncratic economic and political events. In response, central banks have had to choose between letting exchange rates fluctuate according to supply and demand, mitigating fluctuations through interventions in foreign exchange markets, and/or through manipulations of interest rates. While these interventions have the potential to stabilize foreign exchange rates among Latin American countries, the long-term efficacy of such interventions is remains uncertain.

A recent study by Martin Tobal and Renato Yslas from the Central Bank of Mexico compared two different models of foreign exchange (FX) interventions: one in Mexico and one in Brazil. For each model, they examine its impact on the exchange rate, the inflation rate, and the interaction between the exchange rate and interest rate from 2000 to 2013. The two models differ in several characteristics. Overall, Mexican interventions resulted in the sale of U.S. dollars by the central Bank based on a predetermined rule, and only on an occasional basis (such as during the 1995 crisis and in the aftermath of the 2008 financial crisis). By contrast, the Central Bank of Brazil had purchased U.S. dollars in the foreign exchange market on a regular, discretionary basis-without publicly disclosing the amount that was being purchased. The effects of these two models on each country’s exchange rate, inflation rate, and interest rate were varied.

First, FX interventions between 2000 and 2013 had a short-term impact on the exchange rate in both countries: lasting two months for Mexico and one month for Brazil. Second, FX interventions did not result in inflation costs in Mexico, but did in Brazil. Inflation rates were examined at two stages following the FX interventions: after one month, and after two years. In Brazil, 3.7 percent (after one month) and 20. …

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