The Effects of foreign exchange intervention policy in Korea

Abstract

Most countries engage in indirect intervention in the foreign exchange market in order to stabilize the exchange rate under a flexible exchange rate regime, even though the exchange rate is mainly determined in the foreign exchange market. This empirical study , using the change in net foreign asset as a proxy variable of the intervention, shows that the intervention increases the volatility of the exchange rate and raises the level of exchange rate only in the short run. However, the positive aspect of the intervention is that it did not increase the volatility of the exchange rate during the period after the financial crisis. This implies that the policy of improvement in foreign reserves contributes to the stability of the foreign exchange market. To have an effective intervention policy in the future, the government needs to restore credibility through the consistent policy action and conduct complete analysis of exchange traders’ behavior.