Central Bank Intervention Research Articles

Inflation Target In Emerging Countries: Modeling Exchange Rate Issues

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt; mso-bidi-font-style: italic; mso-bidi-font-size: 12.0pt;"><span style="font-family: Times New Roman;">The idea of inflation targeting in emerging countries is not a new one. There have been papers that favor or reject the idea of implementing such a system in these countries for mainly institutional reasons. This paper does not deal with these normative arguments. Emerging countries are implementing IT regimes and therefore it is necessary to understand how it should be done and what problems can arise. Therefore this paper focuses on exchange rate issues for inflation targeting. These issues have their root in the basic relation that exists in emerging countries between inflation and the exchange rate, a relation known as the “pass through effect”. The simple setup used in this paper shows how the monetary authorities implementing an IT regime must intervene in the exchange rate market in order to comply with the inflation target. The central bank intervenes in order to avoid exchange rate movements that would affect the overall inflation rate through the pass-through effect. These results mean that the dirty floating or fear of floating hypothesis should be modified when applied to countries implementing IT, since their intervention (or dirty floating activities) may be justified.</span></span></p>

Technical Analysis in the Foreign Exchange Market

This article introduces the subject of technical analysis in the foreign exchange market, with emphasis on its importance for questions of market efficiency. “Technicians” view their craft, the study of price patterns, as exploiting traders’ psychological regularities. The literature on technical analysis has established that simple technical trading rules on dollar exchange rates provided 15 years of positive, risk-adjusted returns during the 1970s and 80s before those returns were extinguished. More recently, more complex and less studied rules have produced more modest returns for a similar length of time. Conventional explanations that rely on risk adjustment and/or central bank intervention do not plausibly justify the observed excess returns from following simple technical trading rules. Psychological biases, however, could contribute to the profitability of these rules. We view the observed pattern of excess returns to technical trading rules as being consistent with an adaptive markets view of the world.

Japanese central bank interventions and the dispersion of individual exchange rate expectations: differential impact on four moment characteristics

We investigate the influence of Japanese central bank interventions on market participants' opinions about the future path of exchange rates. Based on a survey of individual forecasts made by 31 analysts, we investigate the sensitivity of the change, dispersion, directionality and flatness of expectation distributions between January 1995 and December 2004. In line with previous findings, we provide evidence that exchange rate market volatility is positively linked to the degree of dispersion among market participants' expectations. Only large and transparent central bank interventions have a significant influence on market participants' opinions about the future path of exchange rates. Uncertainty is exclusively reduced among 12-month forecasts. It should be stressed furthermore that for these forecasts positive interest rate spreads and interventions are shown to have an asymmetric impact on heterogeneity: they tend to increase the degree of consensus among forecasters who attach more weight to a stronger yen and to increase the degree of disagreement among the others.

Monetary Policy Trade-Offs in a Portfolio Model with Endogenous Asset Supply

This paper develops an open economy portfolio balance model with endogenous asset supply. Domestic producers choose an optimal capital structure and finance capital goods through credit, bonds and equity assets. Private households hold a portfolio of domestic and foreign assets, shift balances depending on risk-return considerations, and maximise real consumption in accordance with the law of one price.Within this general equilibrium model, it will be shown that central bank interventions may promote an inefficient international allocation of real capital. The application of expansive monetary interventions throughout the course of economic crises maintains the domestic stock of real capital at the cost of inflation, currency devaluation, distortions of interest rates and asset prices, and risk clusters on the central bank’s balance sheet. Exchange rate stabilising interventions have the result that the central bank can also stabilise the domestic stock of real capital. However, such interventions produce risk clusters on the central bank’s balance sheet and may cause changes in the domestic price level.

异质交易者模型与中央银行汇市干预有效性分析：以日本为例 Heterogeneous Agents Model and the Effectiveness of Official Intervention in the Foreign Exchange Market: Evidence from Japan

本研究以Westerhoff & Reitz (2003) 的模型为基础，将金融市场常见的反向操作行为纳入外汇市场汇率走势变化分析。研究中除讨论反向操作策略是否存在于外汇市场外，并探讨中央银行汇市干预是否会影响基本分析者与反向操作者参与市场的行为，讨论央行能否透过Taylor (2004,2005) 之整合管道以及 Hung(1997) 之噪音交易管道，达到其干预与影响外汇市场之目的。实证内容以日本银行外汇市场实际干预资料为依据。实证结果指出日本银行的汇市干预的确可以同时透过整合管道与噪音交易管道，影响基本分析者以及反向操作者参与市场的意愿。随着央行干预力量的增强，基本分析者以及反向操作者参与的市场的意愿也随之提高，使得央行可以藉此达到扭转汇率走势，修正汇率错向调整变化等汇市干预所欲完成的目标。 A nonlinear microstructure model based on Westerhoff & Reitz (2003) is employed to discuss the influences of central bank intervention on heterogeneous agents’ behaviors in the yen/dollar exchange market. The effectiveness of two hypothetical channels proposed by Hung (1997) and Taylor (2004, 2005) respectively are tested. Empirical evidence suggests the extrapolative price movements resulted by chartist’s behavior are successfully depressed by the increased strength of contrarian trading which is induced by an official intervention operation. This result supports Hung’s noise trading channel hypothesis which asserts an effective intervention may convince the chartists of the coming break in the current trend. Our result also shows the fundamentalists’ confidence is enhanced by an intervention operation, and supports Taylor’s co-ordination channel hypothesis. The coordination channel proposes a coordinating role of central bank in or-ganizing fundamentalists’ behaviors and directing the market to its fundamental equilibrium.

How Does Public Information on Central Bank Intervention Strategies Affect Exchange Rate Volatility? The Case of Peru

Intervention operations in the foreign exchange market are used by the Banco Central de Reserva del Peru to manage both the level and volatility of their exchange rates. The Banco Central de Reserva del Peru provides information to the market about the specific hours of the day interventions would take place and the total amount of intervention. It consistently buys and sells on the foreign exchange market to avoid large appreciations and depreciations of the Peruvian nuevo sol against the U.S. dollar (Sol/USD), respectively. The estimates in this paper indicate that past information on interventions has moved the sol in the intended direction but only during the time the Banco Central de Reserva del Peru has announced it would be active in the foreign exchange market. The authors also find that the expectation of future interventions by the Banco Central de Reserva del Peru decreases the volatility of the sol when it intervenes to avoid an appreciation of the sol; however, the opposite occurs when the intervention takes place to defend the sol from depreciation. Indeed, the sol has been less volatile during periods when the Banco Central de Reserva del Peru has intervened than otherwise.

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

This paper presents a theoretical framework analyzing 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 central bank. The model is used to analyze the impact of Japanese FX interventions during the period 1999-2011 on the yen/US dollar dynamics.

The Financial Crisis of 2007–09 and Emerging Countries: The Political Economy Analysis of Central Banks in the Brazilian and Korean Economies

Insofar as the global crisis of 2007–09 can be understood as a fully-fledged crisis of the financialization era, it has presented new challenges for central banks. However, this paper argues that the central banks' interventions in key middle income countries (Brazil and Korea) have reinforced the main characteristics of financialization and have been different from their previous foreign exchange crisis of the late 1990s. The key reasons for this sharp contrast in central bank interventions can be found in the origins of the recent crisis — in developed financial markets — which is different from the previous one which originated in emerging markets. Furthermore, the higher level of financial integration of both economies in relation to the late 1990s is a more important factor. The Korean and Brazilian experiences show that liquidity management by central banks has been conditioned by international capital flows, and more importantly they have reinforced this trend through their operations in spite of differences in the dynamics of capital flows, in their timing of reserve accumulation and in their level of financial integration.

(De)Financialization and Crisis in Eastern Europe

This paper investigates how financialization pressures in Eastern Europe shaped vulnerabilities to the 2007 global deleveraging and to what extent policy responses to crisis have sought to reinforce or delink from financialization. It explores the technical devices underpinning financialization, linked to the dominance of carry-trade strategies in foreign-owned banks and nonresident investors, validated by a set of central bank practices that changed the relationship between wholesale money markets and currency markets. Three distinct periods in the timeline of crisis show that central bank interventions were crucial in resuscitating financialization and that attempts to re-embed finance cannot be successful if public debt dynamics are neglected.

Speculative Positioning Around Episodes of Central Bank Intervention: Evidence from the Yen/Dollar Market

This paper examines the central bank intervention in the yen/dollar market and its influence on the foreign exchange traders' speculative positions. We observe that speculators predominantly take up the opposite side of the transaction to the central bank. They appear to increase their relative yen positions when central banks sell yen and lower them when they buy yen. Our results indicate that interventions are more successful when speculators act with the central bank but generally ineffective when they take the other side of the transaction.

Effects of Central Bank Intervention on the Interbank Market During the Subprime Crisis

We explore whether central bank intervention improves liquidity in the interbank market during the current subprime crisis with unique trade and quote data from the e-MID, the only regulated electronic interbank market in the world. Central bank intervention consistently creates greater uncertainty in the interbank market. Prior to the crisis, the cover-to-bid ratio effectively conveys good and bad news from the central bank, but this link is broken during the crisis, suggesting that standard (and special) interventions that do not specifically target interbank asymmetric information fail to improve market liquidity. Our results suggest that the central bank should release stress tests for individual banks, provide interbank loan guarantees, or engage in direct asset purchases rather than simply providing more capital when counterparty risk poses systemic risk to the interbank market. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Order flow and central bank intervention: An empirical analysis of recent Bank of Japan actions in the foreign exchange market

This paper examines the behaviour of end-user order flows in the foreign exchange market around periods of intense and large-scale intervention activity by the Bank of Japan. First, we find very limited evidence that corporate customers are more than usually likely to be net sellers of yen on days when the Bank of Japan is intervening to sell yen. However, there is somewhat stronger evidence that financial customers are more likely to be net buyers of yen on the same days. Second, we find very clear evidence that intervention matters in a microstructure analysis. The strong contemporaneous correlation between order flows and exchange rate changes essentially disappears on days in which the Bank of Japan intervenes.

Can intervention indices detect central bank's actual intervention behaviour?

This article employs the Weymark (1997) and Baig et al. (2003) models to evaluate the central bank's intervention behaviour and utilizes ex post intervention news to check the models' estimation results. Empirical results show that the Baig et al. model's evaluation performance in intervention behaviour is inferior to the Weymark model. The scale of intervention index is not an excellent indicator to detect intervention behaviour. Intervention indices and intervention news all support that the intervention frequency in expansion period is higher than in recession period and in face of fatal events the intervention exhibits cluster phenomenon.

A test for the presence of central bank intervention in the foreign exchange market with an application to the Bank of Canada

In this article, a general nonlinear simultaneous equations framework for the econometric analysis of models of intervention in foreign exchange markets by central banks in response to deviations of exchange rates from target levels is proposed. The instrumental variables estimation of possibly nonlinear response functions and tests of intervention, when the functional form may be nonlinear, asymmetric, and may contain unknown shape parameters, is considered. The methodology applies techniques developed for testing in the presence of nuisance parameters unidentified under a null hypothesis to a nonlinear simultaneous equations model. The results of an empirical analysis of stabilization activity of the Bank of Canada, for the period from 1953 to 2009, with regard to the Canada–U.S exchange rate are reported here. A nonlinear specification is found necessary to capture activity after 1998.

THE EFFICACY OF CENTRAL BANK INTERVENTION ON THE FOREIGN EXCHANGE MARKET: UGANDA'S EXPERIENCE

AbstractThis paper employs conditional probabilities generated from a homogenous two‐state Markov chain to obtain maximum likelihood estimates of the efficacy of central bank intervention on the foreign exchange market in Uganda. This enables us to explicitly model the fact that intervention actions usually do not target the exchange rate itself but rather its orderly movement. The results suggest that seasonal pressures are largely responsible for moving the short‐term exchange rate process between the different state spaces. Intervention reduces the probability of the exchange rate process staying in a regime characterised by sharp and disruptive tendencies. Copyright © 2010 John Wiley & Sons, Ltd.

Central Bank Intervention: Preempting Asset Price Bubble

Most of the economic theory delves into monetary policy based intervention in the event market experiences an asset price bubble therefore, sidelining the role of regulatory intervention. The existence of time lag between the monetary policy implementation and its resultant effects raises doubts as to the viability of such an intervention to tackle bubbles. In addition, the monetary policy intervention affects all the sectors of the economy equally notwithstanding the fact that bubbles evolve in few sectors of the economy. The 90’s dot com and recent real estate bubble require focused intervention based on sector experiencing a bubble apart from the whole economy. Relying on regulatory intervention framework, we explore that central banks can intervene by capping the lending activity in order to preempt the bubble in a particular sector. With such strategy, central bank can achieve its monetary policy target while avoiding the side effects associated with traditional intervention.

The Role of Central Banks and Competition Policies in the Rescue and Recapitalisation of Financial Institutions During (and in the Aftermath of) the Financial Crisis

Recent years have witnessed a change in focus from considerations of factors which could impede competition, for example over-regulation, to the need to strike a balance between over-regulation and insufficient regulation – in order to provide the right level of safety for consumers (such that they are protected from risky investments). A driving force behind the need for deregulation over the past two decades has been the objective and desire to foster competition. Re-regulation thereafter assumed centre stage in some jurisdictions in response to the need to manage cross sector services' risks more efficiently. Rescue cases involving guarantees (contrasted with restructuring cases) during the recent Financial Crisis, have illustrated the prominent position which the goal of promoting financial stability has assumed over that of the prevention or limitation of possible distortions of competition which may arise when granting State aid. The importance attached to maintaining and promoting financial stability - as well as the need to facilitate rescue and restructuring measures aimed at preventing systemically relevant financial institutions from failure, demonstrate how far authorities are willing to overlook certain competition policies. However increased government and central bank intervention also simultaneously trigger the usual concerns – which include moral hazard and the danger of serving as long term substitutes for market discipline. An interesting observation derives from the relationship between State aid grants, competition, and the potential to induce higher risk taking levels. Whilst the need to promote and maintain financial stability is paramount, safeguards need to be implemented and enforced to ensure that measures geared towards the aim of sustaining system stability (measures such as lender of last resort arrangements and State rescues) do not unduly distort competition as well as induce higher risk taking levels. This paper will draw attention to safeguards which have been provided by the Commission where approval is considered for the grant of State aid to financial institutions whose problems are attributable to inefficiencies, poor asset liability management or risky strategies. Whether the distinction drawn by the Commission – with regards to the preferential grant of recapitalisation packages to fundamentally sound banks (which require less restructuring measures)is justified, will also be considered. How far central banks and governments should intervene and how far distortions of competition should be permitted ultimately depends on how systemically relevant a financial institution is.

The Need for Government and Central Bank Intervention in Financial Regulation: Free Banking and the Challenges of Information Uncertainty

Through a focus on the ever increasing need to address information asymmetries, as well as reference to the uniqueness of the degree to which systemic risks are triggered in banking, this paper aims primarily to highlight reasons why government and central bank intervention are essential and required in financial regulation. The role presently assumed by regulation is not the same as it was thirty years ago. Deregulation and conglomeration have significantly altered the landscape in which regulation previously existed and to an extent, defined the role which it presently assumes. For this reason, arguments which were (and have been) directed against government, central bank intervention, as well as the role of regulation, require re-evaluation. Deposit insurance and lender of last resort arrangements serve to instil confidence in depositors hence contributing towards safeguarding system stability and preventing unnecessary runs where panics occur. Such benefits are not only considered against those arguments advanced by antagonists of deposit insurance and lender of last resort arrangements, but also against those views which do not favour government and central bank intervention. In evaluating whether free banking is equipped with as many mechanisms and safeguards required in safeguarding the stability of the financial system, the urgency for such safety net instruments, which is attributed to the peculiar and unique nature of banking, will be considered. Contrary to the argument [that “if markets are generally better at allocating resources than governments are, then the differences or distinctions which exist between “money” and the industry that provides it (the banking industry) should not serve as bases for an assumption that money and banking are exceptions to the general rule”], it has to be highlighted (for several reasons) that the banking industry could not be equated to other areas of the financial sector. One of such reasons relates to the extent to which the impact of systemic runs differ within the banking sector when compared to other areas such as the securities markets. The differences in the nature of risks which exist in banking and those which exist within the securities markets, constitutes another reason why the need for government and central bank intervention is advocated. Furthermore, even though the nature of banking risks warrants government and central bank intervention – as well as capital adequacy regulation, capital regulation should also be extended to the securities markets for many reasons – one of which is the ability to securitise assets. If there was no longer a role for regulation, then re- regulation should not have occurred in certain jurisdictions which have adopted and successfully implemented consolidated supervision.

Off-the-record target zones: theory with an application to Hong Kong’s currency board

This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmetric one-sided regimes. Market participants’ beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong’s one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities finally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.

Off-the-Record Target Zones: Theory with an Application to Hong Kong's Currency Board

This paper provides a modelling framework for evaluating the exchange rate dynamics of a target zone regime with undisclosed bands. We generalize the literature to allow for asymmetric one-sided regimes. Market participants' beliefs concerning an undisclosed band change as they learn more about central bank intervention policy. We apply the model to Hong Kong's one-sided currency board mechanism. In autumn 2003, the Hong Kong dollar appreciated from close to 7.80 per US dollar to 7.70, as investors feared that the currency board would be abandoned. In the wake of this appreciation, the monetary authorities finally revamped the regime as a symmetric two-sided system with a narrow exchange rate band.