Implementing a minimum exchange rate regime by buying foreign currency eases monetary conditions domestically and may thus have a direct impact on the inflation rate. However, such foreign currency purchases involve a risky expansion of the central bank’s balance sheet total. A new model can now predict what expansion of the balance sheet a central bank must expect if it wishes to implement a minimum exchange rate in the foreign exchange market.Since the 2007-08 financial crisis, the policy rates of numerous central banks worldwide have been close to the natural lower bound for nominal interest rates of slightly below 0%. It is therefore virtually impossible to lower the policy rate any further. In order to remain capable of monetary policy action in a low interest rate environment and, say, be able to influence future inflation rates, central banks have, for years now, employed unconventional monetary policy measures. These include, for instance, asset purchase programmes and exchange...
