Sterilized Foreign Exchange Interventions and Central Bank Credibility under Inflation Targeting Regimes: Evidence from Romania

This paper studies the relationship between sterilized foreign exchange interventions and the credibility of inflation targeting regimes with a focus on the National Bank of Romania (NBR). Although inflation targeting theoretically relies on a flexible exchange rate and clear communication, central banks in emerging market economies often intervene in foreign exchange markets to smooth excessive currency volatility. Using a combination of institutional analysis and empirical evidence for Romania over the period 2007–2024, the study investigates the interaction between exchange rate dynamics, sovereign risk perceptions, and changes in foreign currency reserves. The empirical analysis employs a Vector Autoregression (VAR) model to capture the dynamic relationships between exchange rate returns, sovereign spreads, and reserve variations, and also a GARCH(1,1) model in order to examine the determinants of exchange rate volatility. The results suggest that exchange rate volatility exhibits strong persistence, while reserve variations are associated with a reduction in conditional exchange rate volatility. Impulse response analysis further indicates that the effects of reserve shocks on exchange rate dynamics and sovereign spreads are primarily temporary. Overall, the findings suggest that sterilized foreign exchange interventions may contribute to stabilizing exchange rate fluctuations in the short term without fundamentally contradicting the inflation targeting framework. However, the credibility implications of such interventions depend on the consistency between policy actions and communication, as well as on the transparency of the central bank’s policy framework.