Sustainable Intervention Policies and Exchange Rate Dynamics

Recently developed models of exchange rate dynamics emphasize the expectational effects of infrequent intervention. This paper proposes a stylized probabilistic framework in which such effects can be studied along with realistic concerns about the sustainability of the intervention policy. In this framework, the level of reserves determines the extent to which non-linear intervention affects the level of exchange rates and their sensitivity to movements in fundamentals. We show that all such effects are absent when the possible reserve levels are weighted by their long-run probabilities.