Abstract

ABSTRACT:

Bangladesh Bank, the central Bank of Bangladesh is committed to maintain price stability and facilitate economic growth through conventional monetary policy. Although Bangladesh entered the regime of floating exchange rate in 2003, central bank intervenes to minimize excessive fluctuation in exchange rate through foreign exchange intervention policy. While these two policies work simultaneously, there was no study to examine the performance and effectiveness of these policies and understand their interaction in the framework of a joint analysis. The paper intends to fill up this gap. The paper develops a structural vector autoregression (SVAR) model to understand how foreign exchange intervention and conventional monetary policy affects the economy along with the endogenous reaction of policy variables. The intervention policy and conventional monetary policy are jointly analyzed to understand the interaction between them and also their impact on exchange rate and other economic variables i.e., price levels, real economic activity and real financial asset prices. The SVAR model is identified through relevant exclusion restriction based on the literature and the reality of the economy of Bangladesh. Monthly data of the relevant variables from July 2003 to December 2014 are used to estimate the model. Impulse response function is used to reveal the impact of policy and other shocks.Results reveal that foreign exchange intervention shocks have significant effects on the Taka / US $ exchange rate and the contribution of foreign exchange intervention shocks to exchange rate fluctuation is larger than that of monetary policy shocks. However, intervention shock has virtually no impact on price level, economic activity and real asset price supporting sterilization. On the other hand, while conventional monetary policy has insignificant effect on relevant variables when its effect is examined excluding foreign exchange intervention policy, it has mostly significant impact on economic variables when joint analysis is conducted. Both monetary policy variable and foreign exchange intervention variable react to each other significantly, suggesting the usefulness of this joint analysis. Results also reveal appropriate policy reaction to economic situation. Central Bank's policy interventions are working pretty well in achieving internal and external stability of the value of local currency. Hence, present framework of exchange rate intervention and monetary policy may be continued without any major overhaul. However, monetary policy has limited impact on economic activity measured by industrial production. Hence, to the extent growth is adversely affected by inflation and exchange rate fluctuation, the central bank may work towards achieving higher growth indirectly by maintaining low inflation and exchange rate stability.

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