Abstract
This paper investigates the relationship between international reserves changes and foreign exchange rate movements for five Far Eastern countries (China, Japan, Taiwan, Hong Kong, and Korea) from January 1997 to May 2020. We use the quantile Granger causality test and the quantile autoregressive model to capture the monetary authorities’ motivations for intervention. The primary results of this study are as follows. First, in China and Hong Kong, we capture the mercantilists’ motive of accumulating their international reserves for the purpose of responding to the appreciation of currencies. Relatively speaking, the monetary authorities’ motivation for precautionary stabilizing their currencies is high in Korea and Japan. Second, we identify the asymmetric causal relationship between the variables. Considering the causal relationship with significant regression coefficients, these characteristics are found to be more evident in all countries. Last, we confirm the properties of the quantile- and tail-dependent relationship between the variables. In particular, Korea has a relatively stronger tail-dependence than other countries. That is, the causal relationship between the Korean foreign exchange reserves and the exchange rate is stronger at the rapid fluctuations of the variables, and this relationship is weakened at the moderate fluctuations of them.
Highlights
The collapse of the Bretton Woods fixed exchange rate system in the early 1970s initiated the flexible exchange rate system
In the traditional theory of monetary policy, if the monetary authority changes the amount of money in the market as opposed to increasing or decreasing its international reserves, the value of that country’s currency changes; this strategy is called the unsterilized policy
If the change in international reserves does not affect the foreign exchange rate, it can be interpreted that the monetary authority has successfully intervened by using the sterilized policy
Summary
The collapse of the Bretton Woods fixed exchange rate system in the early 1970s initiated the flexible exchange rate system. Most countries have chosen a pure flexible exchange rate system, in which monetary authorities do not intervene at all in their foreign exchange market. The rate at which a country accumulates foreign exchange reserves to defend fixed exchange rates has not changed even after the adoption of a flexible exchange rate system. This can be seen as a sign of scepticism about the flexible exchange rate system. The flexible exchange rate system faced problems of high exchange rate volatility and weakening competitiveness in the major developed countries. Policymakers have been tasked with adjusting the advantages of flexibility of exchange rate as a shock absorber on one hand and as a mechanism to facilitate international competitiveness and macroeconomic stability on the other
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