Albania: Selected Issues

This Selected Issues paper examines the case for foreign exchange intervention (FXI) in the context of Albania by estimating an integrated policy framework (IPF) model to quantitatively illustrate relevant policy trade-offs. A version of the quantitative IPF (QIPF) model is estimated for Albania, with the aim to examine the merits of FXI in response to shocks amid shallow FX markets. Two specific types of shocks are considered, namely: (1) a fundamental shock in the form of a tourism boom, and (2) a nonfundamental shock in the form of exogenous portfolio inflows caused by a risk-on episode. Exchange rate volatility driven by nonfundamental factors may present policymakers with a trade-off between stabilization objectives. Adverse impacts from risk shocks can be addressed using FXI. A better tool to address temporary inefficient capital flow shocks is a sterilized FX intervention, provided that markets are sufficiently shallow and an appropriate buffer of reserves is available. Consideration should be given to letting the exchange rate adjust more flexibly and relying on interest rate policy as the primary tool for price stability. In cases of nonfundamental shocks, the scenario analysis suggests that interventions could be beneficial by lowering output and inflation volatility. In doing so, however, the authorities should internalize the potential adverse consequences of FXI, including on risks to the central bank balance sheet, interest rate transmission, and financial market development.