Foreign exchange intervention in Colombia

This paper describes the Banco de la República’s FX intervention policy, with a focus on its objectives and main features. It then argues, based on a review of the literature on the effectiveness of sterilized intervention in Colombia, that this tool is not a useful way of coping with the challenges posed by medium-term external factors such as quantitative easing in advanced economies, reduced risk premiums in emerging economies or high international commodity prices. The impact of sterilized intervention on the exchange rate (if any) is of much shorter duration than are the effects of those external factors. Finally, the paper argues that if sterilized FX intervention is effective through the operation of the portfolio balance channel, it may also have an expansionary effect on credit supply and aggregate demand. In this case, the macroeconomic outcomes of intervention depend on the monetary policy response. This issue is studied with a small open economy DSGE model. In general, FX intervention creates more volatility of credit and consumption than occurs with more efficient allocation and under alternative monetary regimes without intervention. Furthermore, the more inclined the central bank is to meet an inflation target, the stronger its response to the expansionary effects of the intervention, and consequently the lower the impact of the intervention on the exchange rate.