Central Bank Intervention Research Articles

Trade intensity and purchasing power parity

In this paper, we seek to contribute to the PPP literature by presenting evidence of a link between trade intensity and exchange rate dynamics. We first establish a negative effect of trade intensity on exchange rate volatility using panel regressions, with distance as an instrument to correct for endogeneity. We also estimate a nonlinear model of mean reversion to compute half-lives of deviations of bilateral exchange rates from the levels dictated by relative PPP, and find these half-lives to be significantly shorter for high trade intensity currency pairs. This result does not appear to be driven by Central Bank intervention. Finally, we show that conditioning on PPP may help improve the performance of popular currency trading strategies, such as the carry trade, especially for low trade intensity currency pairs.

Exchange Rate and Central Bank Intervention

Exchange rate and central bank intervention is an important topic in the exchange rate determination [1-4]. Exchange rates are volatile after the breakdown of the Bretton Woods system of fixed exchange rate in the year 1973. Central banks especially those in economies adopted a managed exchange rate regime actively intervene in the exchange rate market to maintain their exchange rates and to reduce their exchange rate volatility, which can affect international trade, financial flow and economic growth. Central bank intervention in the exchange rate market may want to accrue international reserves to enhance the fundamental of the economy [5]. There are two important issues related to the exchange rate intervention, namely the effectiveness of central bank intervention and the success of central bank in maintaining the exchange rate and in reducing exchange rate volatility [1,4,6]. In general, the literature of exchange rate and central bank intervention is inconclusive on the impact of central bank intervention. Most studies conclude that central bank intervention tends to increase exchange rate volatility.

Exchange Rate Expectations, Unbiasedness and Central Bank Intervention: The Experience of the Southern Cone

This paper uses new survey data on foreign exchange expectations for Argentina, Brazil and Uruguay to test the hypothesis of unbiasedness. The pattern emerging is revealing: only Argentinean forecasts are unbiased predictors of exchange rate movements, while agents err systematically for Brazil and Uruguay. We argue that the systematic intervention of the Argentinean Central Bank in the foreign exchange market is likely to explain this result, as it simplifies the forecast exercise in that market. As long as the requirements to predict well are simple, agents perform well. If instead the exchange rate determination model is intricate, expectation failures arise.

Optimal Exchange Rate Policy in a Growing Semi-Open Economy

In this paper, we consider an alternative perspective to China's exchange rate policy. We study a semi-open economy where the private sector has no access to international capital markets but the central bank has full access. Moreover, we assume limited financial development generating a large demand for saving instruments by the private sector. We analyze the optimal exchange rate policy by modelling the central bank as a Ramsey planner. Our main result is that in a growth acceleration episode it is optimal to have an initial real depreciation of the currency combined with an accumulation of reserves, which is consistent with the Chinese experience. This depreciation is followed by an appreciation in the long run. We also show that the optimal exchange rate path is close to the one that would result in an economy with full capital mobility and no central bank intervention.

Modeling Money Market Spreads: What do we Learn about Refinancing Risk?

We quantify the effect of refinancing risk on euro area money market spreads, a major factor driving spreads during the financing crisis. With the advent of the crisis, market participants' perception of their ability to refinance over a given period of time changed radically. As a result, borrowers preferred to obtain funding for longer tenors and lenders were willing to provide funding for shorter tenors. This discrepancy resulted in a need to refinance more frequently in order to borrow over a given horizon, thus increasing refinancing risk. We measure refinancing risk by quantifying the sensitivity of the spread to the refinancing frequency. In order to do so we introduce a model to price EURIBOR-based money market spreads vis-à-vis the overnight index swap. We adopt a methodology akin to a factor model in which the parameters determining the spreads are the intensity of the crisis, its expected half-life, and the sensitivity of spreads to the refinancing frequency. Results suggest that refinancing risk affects the spread significantly across time, albeit in a largely varying manner. Central bank interventions have reduced the spreads as well as the effect of refinancing risk on them.

Modelling the High Frequency Exchange Rate in Romania with FIGARCH

Romanian forex market is an emerging market with periods of high volatility. The Romanian exchange rate was for a long term on a depreciating trend in nominal terms interrupted by short bursts of appreciation. The paper applies a FIGARCH model (Beine at al., 2002) for measuring the volatility of exchange rates in order to see how the forex market actors react to shocks in the exchange rate. We used daily data of Ron-Euro exchange rate between 2007 and 2012. Our results indicate that the exchange rate is highly fractionally integrated, indicating a fast process of mean reversion. The source of the exchange rate persistence is difficult to be explained and may be accounted for by unobserved factors or by the central bank intervention. If there are structural breaks in data, then the exchange rate could falsely indicate persistence in the data. In order to test for the spurious long-memory, we used a Zivot-Andrews Unit Root Test.

Banks, Markets, and Financial Stability

In a theoretical model of the Diamond-Dybvig style, in which deposit-taking banks and financial markets coexist, bank behavior is analyzed taking into account a positive ex-ante probability of a future financial crisis. We focus on the role of the interaction of market liquidity and banks' funding liquidity in the propagation of shocks in the financial system. Our findings suggest that in particular bank-dominated financial systems are prone to contagious bank runs due to asset price deteriorations as a consequence of fire sales of assets in financial markets. Nevertheless, banks only prefer holding liquidity buffers to weather future crises if the ex-ante crisis probability exceeds a certain threshold. Moreover, central bank interventions are shown to have destabilizing effects because they reduce banks' incentives to hold liquidity buffers. This can be interpreted as a justification for prudential regulation in terms of minimum liquidity buffer requirements.

Modeling Money Market Spreads: What Do We Learn About Refinancing Risk?

We quantify the effect of refinancing risk on euro area money market spreads, a major factor driving spreads during the financing crisis. With the advent of the crisis, market participants' perception of their ability to refinance over a given period of time changed radically. As a result, borrowers preferred to obtain funding for longer tenors and lenders were willing to provide funding for shorter tenors. This discrepancy resulted in a need to refinance more frequently in order to borrow over a given horizon, thus increasing refinancing risk. We measure refinancing risk by quantifying the sensitivity of the spread to the refinancing frequency. In order to do so we introduce a model to price EURIBOR-based money market spreads vis-a-vis the overnight index swap. We adopt a methodology akin to a factor model in which the parameters determining the spreads are the intensity of the crisis, its expected half-life, and the sensitivity of spreads to the refinancing frequency. Results suggest that refinancing risk affects the spread significantly across time, albeit in a largely varying manner. Central bank interventions have reduced the spreads as well as the effect of refinancing risk on them.

A tale of two economies : The gap growing

A tale of two economies : The gap growing

Comment on “A Pass-Through Revival”

Exchange rate adjustments … weren't always reflected in the final prices of exports and imports. Following the last upward valuation of the Japanese yen, many Japanese exporters simply absorbed the increase, reducing their profit margins instead of raising prices. And many American international companies took the last dollar devaluation as an opportunity to increase the profit margins of their overseas affiliates instead of cutting prices. In the exchange rate pass-through literature, the seminal theoretical paper by Dornbusch (1987) emphasizes the price setting role of exporters in imperfectly competition markets to explain the less than proportionate response of export prices to exchange rate fluctuations. After Dornbusch (1987), a large number of theoretical and empirical studies have focused on the price-setting behaviors of exporters. Surely the important policy implications of exchange rate pass-through are originally on import side, but as discussed above, the developments in this research area have been inclined more toward exporters' pricing behaviors. Now given the current situation in Japan that after the decades-long period of small-inflation (or deflation), the change in monetary policy of Japan calls for inflation of 2% within two years, our attention should be focused more on the price transmission from import prices to final consumer prices. In this sense, I totally agree with Shioji's (2014) emphasis that discussions of the “pass-through on import side” need to be revived. Now, it remains to evaluate quantitatively how important this channel is for inflation in Japan. Shioji's paper investigates the price transmission mechanism by examining prices at different stages: the import price; prices at intermediate stages; and the consumer price. Price series are included in a standard vector autoregressive model (VAR) and a more sophisticated VAR with time-varying coefficients and stochastic volatilities. The impulse responses of the standard VAR model in Shioji's (2014) Figure 2 and Table 2 indicate an upward shift in recent years. In addition, taking advantage of the time-varying coefficients VAR, the impulse response in different periods are tested to see whether the degree of pass-through transmission has changed over time. Shioji finds evidence for an increase in the degree of pass-through in the latest period (see Shioji's, (2014) Figure 3 and Table 3), and concludes that exchange rate pass-through to import prices has risen. Shioji further relates the cause of pass-through changes to the change in the proportion of imported inputs (in terms of value) using input-output analysis. How relevant is this pass-through issue to current Japan's monetary policy? Shioji answers this question by giving a rough forecast of the impact of the 25% depreciation of the Japanese yen on inflation to be 1% in 6 months. Thus, I agree that “pass-through revival” is normatively important in Japan's current economic situation, that is, an economy that has suffered deflation for a long period and has a zero-lower-bound interest rate, as well as being quantitatively important for the inflation target of two percent in 2 years. Having said that and with all due respect to Shioji's paper, I shall raise one issue that I am not completely in agreement with Shioji. In the introduction of his paper, Shioji (2014, p. 121) argues that “this apparent revival of pass-through likely means that the central bank has regained an important transmission mechanism of its policy to the private sector.” If the Bank of Japan (BoJ) is able to maneuver a depreciation of the Japanese yen, the BoJ may successfully lead the consumer price index (CPI) to its targeted goal of 2% inflation. However, the BoJ cannot rely on direct intervention in the foreign exchange market. The failure or short-lived effects of central bank intervention in foreign exchange markets are well documented, especially in the 2003 and 2004 episodes, and the more recent BoJ interventions after 2010. How and why the Japanese yen depreciated by 25% (without interventions in the foreign exchange markets) between October 2012 and May 2013 needs to be examined more carefully, and further study is warranted. Clarifying quantitatively the underlying mechanism which did not work in the last two decades and that worked in 2012–2013 would strengthen the credibility of the policy tools available to the BoJ as Shioji claims.

Exchange rate regime in India & role of central bank in exchange rate management

This paper studies exchange rate regimes pursued in Indian economy since past decades. The paper has attempted to study transformation from fixed regime to floating or pegged arrangements in India & also the challenges associated with these reforms as brought in 1992. Further , several authors have identified variables to assess the presence of central bank intervention even under the system of floating exchange rate & efficiency of their efforts in targeting the real exchange rate. Finally, it has identified that as per impossible trinity , given the open capital account , a bipolar view seems appropriate in India.

Central bank interventions and eurocurrency markets

The work assesses Eurocurrency markets and possible official interventions for regulating Eurobanking activity. The author first looks at the definition and origins of the Euromarket. Its structure, functioning and dimensions are then analysed. The problem of regulating Eurobanking activity is then taken into consideration as well as the nature and content of possible intervention by official authorities to regulate Eurocurrency flows.

The new ECB and its relationship with the eurozone Member States: Between central bank independence and central bank intervention

The financial and sovereign debt crisis has had a great impact on the relationship between the European Central Bank (ECB) and the Member States of the Eurozone, a relationship traditionally studied from the perspective of central bank independence. This article takes a different perspective on that relationship, namely that of central bank intervention in Member State economic policy making. It focuses on the pressure and influence exercised by the ECB on the Member States of the eurozone. The two perspectives combined reveal the nature of the ever more frequent and intense interaction between the ECB and the Member States of the eurozone. In the crisis, several different forms can be identified of ECB pressure on eurozone Member States to adopt reforms in the areas of fiscal policy and structural reforms, marking a shift from interaction to central bank intervention. This ECB intervention is parallel to an equally unprecedented intervention by the collective of eurozone Member States in the economic policy of several Member States through the economic policy conditionality linked to financial assistance. The article analyses several instances of ECB intervention, offers an explanation and a theoretical framework for normatively assessing it. The main risk identified for the ECB in this article is that of being perceived as a political or politicized actor, although it is acknowledged that the ECB is confronted with a difficult balancing act. The ECB should be more cautious in its approach, the further an issue is from its core mandate of securing price stability.

Central Bank Intervention and the Role of Political Connections

This paper analyzes the characteristics of banks that received emergency loans from the Federal Reserve during the recent financial crisis. Using unique data consisting of emergency loan transactions, I provide evidence that larger banks, in terms of assets and market capitalization, were more likely to receive emergency support. I also show that banks that held more loans, deposits, and investment securities as assets, as well as banks with higher share prices, greater stock trading activity, and more market risk, were more likely to receive support. After controlling for balance sheet characteristics and other measures of bank riskiness, I provide strong evidence that banks that were politically connected?either through lobbying efforts or employment of politically connected individuals?were substantially more likely to receive emergency support from the Federal Reserve. In economic terms, the Federal Reserve was 10?17 percent more likely to give emergency loans to banks that were politically connected than to banks that were not politically connected.

The Portfolio Theory of Exchange Rates Then and Now

In the early 1970s, the portfolio theory of exchange rates with rational expectations was introduced to explain the behavior of floating exchange rates. While attractive in principle, the approach failed along with other theories to provide empirically convincing results. Over the years, the theory has been extended to a general equilibrium setting and modified to include central bank intervention and non‐rational expectations. More recently, it has become a platform for the micro‐structural approach emphasizing order flows, which shows increasing promise as an empirical explanation of exchange rate behavior.

An empirical analysis of China's equilibrium exchange rate: A co-integration approach

This paper estimates time specific values for China's long-run equilibrium exchange rate and develops measures of the direction and extent of misalignment based on a reduced-form real effective exchange rate (REER) model. An appropriately specified long-run equilibrium model is estimated and tested following Johansen and Juselius (1990) procedures, which is then used to construct an estimated time path for long-run equilibrium exchange rate values.Unit root tests indicated that each series can be considered as I(1) and that there was one cointegrating relationship linking the RMB series with its “fundamentals” – openness, money supply, productivity and government spending – with long-run elasticities of (0.41), (0.97), (0.51) and (0.75), respectively. The estimated error-correction model of REER determination showed that during China's latest exchange rate regime (from 2005:Q3) the RMB was undervalued by an average of 6.7 percent, which is modest compared to related studies.Estimation of the associated short-run error correction model shows that the error correction term has a statistically significant value of 0.85, implying that the actual real effective exchange rates would converge relatively quickly (just over one quarter, on average) towards their long-run equilibrium level in the absence of central bank intervention.

Principal component measures of exchange market pressure: comparisons with variance-weighted measures

In studies of currency crises, Exchange Market Pressure (EMP) captures depreciations and central-bank interventions in a single index. However, while the measure's three components are commonly given variance-smoothing weights, this approach has been criticized as problematic. One proposed alternative is to use Principal Components Analysis (PCA) to derive the proper weights. This article examines EMP for 21 countries over the period from 2001 to 2012. While the first principal component never produces weights of the correct sign, some countries’ second (and sometimes third) principal components can be used. We then compare the two measures, finding that the PCA-based measure is highly correlated with the variance-smoothing EMP measure, but that its values are often less extreme. This allows for different definitions of ‘crisis’ periods between the two, and different results in econometric estimations of EMP determinants. As a result, we find that the method of calculating EMP does indeed affect empirical...

Inside Liquidity in Competitive Markets

We study incentives of banks to reserve liquidity given that they can rely on the interbank market to mitigate crisis-related liquidity shocks. Banks can partially pledge their assets to each other, but not to the rest of the economy. Therefore liquidity provision is endogenous. We show that if the probability of a crisis is large or if assets are slightly pledgeable, then all banks reserve liquidity. However, if the probability of a crisis is small or if assets are highly pledgeable, then banks segregate ex ante: some reserve no liquidity, others reserve to the maximum and become liquidity providers. Minimum liquidity requirements improve banks' pro ts only in the symmetric equilibrium. A marginal central bank intervention aimed at lowering the interest rate causes a marginal crowding-out of private liquidity with public liquidity in the symmetric equilibrium, and a full crowding-out in the asymmetric equilibrium.

Interventions and Inflation Expectations in an Inflation Targeting Economy

In this paper we explore the role that exchange rate interventions may play in determining inflation expectations in Chile. To that end, we consider a set of nine deciles of inflation expectations coming from the survey of professional forecasters carried out by the Central Bank of Chile. We consider two episodes of preannounced central bank interventions during the sample period 2007-2012.

The Signalling Channel of Central Bank Interventions: Modelling the Yen/US Dollar Exchange Rate

This paper presents a theoretical framework analysing the signalling channel of exchange rate interventions as an informational trigger. We develop an implicit target zone framework with learning in order to model the signalling channel. The theoretical premise of the model is that interventions convey signals that communicate information about the exchange rate objectives of the central bank. The model is used to analyse the impact of Japanese FX interventions during the period 1999–2011 on the yen/US dollar dynamics.