The International Monetary Fund has expressed worry about the possible long-term implications of foreign exchange intervention by central banks confronted with monetary policy challenges, such as Nigeria.
This was disclosed by International Monetary Fund (IMF) in a document titled, ‘How Africa Can Navigate Growing Monetary Policy Challenges’ released on Monday.
The IMF agreed that mechanisms such as foreign exchange intervention can help to mitigate the consequences of shocks, but that they must be carefully balanced against potential long-term costs.
Furthermore, shallow markets (markets with insufficient liquidity) can accentuate exchange rate swings and produce excessive volatility.
What the IMF is saying
The IMF advised that changes should be structural but acknowledged the progress made by the intervention in the near term.
The IMF said, “Where reserves are adequate and these tools are available, foreign exchange intervention, macroprudential policy measures and capital flow measures can help enhance monetary policy autonomy, improve financial and price stability, and reduce output volatility.”
The IMF added, “This results in higher output and lower inflation than would have been feasible without the use of the additional policy instrument”
However, the IMF warned about possible drawbacks, particularly excessive intervention.
“Importantly, the tools should not be used to maintain an over-or undervalued exchange rate. Moreover, while additional tools can help alleviate short-term tradeoffs, this benefit needs to be carefully weighed against potential longer-term costs,” the IMF said.
International Monetary Fund highlighted potential long term costs which include, “reduced incentives for market development and appropriate risk management in the private sector.”
Furthermore, communicating about the collaborative use of several tools in a more complicated framework can be difficult, and extending the variety of policy alternatives may expose central banks to political pressures.
According to the IMF, central banks will need to weigh the benefits against the potential negative effects on their transparency and credibility, particularly in situations where policy frameworks are not yet well established.