Central bank intervention and exchange rate volatility

Abstract

This paper explores the effects of foreign exchange intervention by central banks on the behavior of exchange rates. The G-3 central banks have undertaken an unprecedented number of both coordinated and unilateral intervention operations in the last 10 years. Existing empirical evidence on the effectiveness of intervention is mixed: studies using data from the 1970s suggest that intervention operations that do not affect the monetary base have, at most, a short-lived influence on exchange rates, but more recent studies indicate that the intervention operations that followed the Plaza Agreement influenced both the level and variance of exchange rates. This paper examines the effects of US, German and Japanese monetary and intervention policies on dollar-mark and dollar-yen exchange rate volatility over the 1977–1994 period. The results indicate that intervention operations generally increase exchange rate volatility. This is particularly true of secret interventions, which are those undertaken by central banks without notification of the public. Overt interventions in the mid-1980s appear to have reduced exchange rate volatility, but in other periods, and for the 1977–1994 period as a whole, central bank intervention is associated with greater exchange rate volatility.