IMF warns of ‘potential longer-term costs’ of CBN foreign exchange interventions

The International Monetary Fund has expressed concern about the possible long-term implications of foreign exchange intervention by central banks facing monetary policy challenges, such as Nigeria.

This was revealed by the International Monetary Fund (IMF) in a document title, ‘How Africa can meet growing monetary policy challenges‘ published on Monday.

The IMF has agreed that mechanisms such as foreign exchange intervention can help mitigate the consequences of shocks, but must be carefully balanced against potential long-term costs.

In addition, shallow markets (markets with insufficient liquidity) can accentuate exchange rate fluctuations and produce excessive volatility.

What the IMF says

The IMF advised that the changes be structural but acknowledged the progress made by short-term intervention.

The IMF said:When reserves are adequate and these tools are available, foreign exchange interventions, macroprudential policy measures and capital flow measures can help to strengthen the autonomy of monetary policy, improve financial and price stability and to reduce the volatility of production.

The IMF added:This results in higher output and lower inflation than would have been possible without the use of the additional policy instrument”

However, the IMF has warned of possible downsides, including over-intervention.

It is important to note that the tools should not be used to maintain an overvalued or undervalued exchange rate. Additionally, while additional tools can help mitigate short-term trade-offs, this benefit must be carefully weighed against the potential longer-term costs.“, said the IMF.

The International Monetary Fund has highlighted the potential long-term costs, including, “reduced incentives for market development and appropriate risk management in the private sector.”

Furthermore, communicating the collaborative use of multiple tools in a more complicated setting can be difficult, and expanding the variety of policy alternatives can expose central banks to political pressure.

According to the IMF, central banks will need to weigh the benefits against the potential negative effects on their transparency and credibility, especially in situations where policy frameworks are not yet well established.

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