A note on optimal foreign reserve management without commitment

Abstract This paper examines optimal policy for foreign exchange (FX) reserve management without commitment. The stylized linear-quadratic model incorporates three key elements: (i) fear of floating, (ii) forward-looking exchange rates, and (iii) the cost of reserve management. The paper first analyzes two benchmark optimal policies: the Ramsey policy (with commitment) and the Markov-Perfect policy (without commitment). It then proposes a sustainable plan that addresses the time inconsistency in reserve management. By following this plan, the government without commitment achieves the Ramsey outcome in equilibrium.