Foreign Exchange Market Intervention Research Articles

A Theory of Managed Floating

After the experience with the currency crises of the 1990s, a broad consensus has emerged among economists that such shocks can only be avoided if countries that decided to maintain unrestricted capital mobility adopt either independently exchange rates or very hard pegs (currency boards, dollarisation). As a consequence of this view which has been enshrined in the so-called impossible trinity all intermediate currency regimes are regarded as inherently unstable. As far as the economic theory is concerned, this view has the attractive feature that it not only fits with the logic of traditional open economy macro models, but also that for both corner solutions (independently exchange rates with a domestically oriented interest rate policy; hard pegs with a completely exchange rate oriented monetary policy) solid theoretical frameworks have been developed. Above all the IMF statistics seem to confirm that intermediate regimes are indeed less and less fashionable by both industrial countries and emerging market economies. However, in the last few years an anomaly has been detected which seriously challenges this paradigm on exchange rate regimes. In their influential cross-country study, Calvo and Reinhart (2000) have shown that many of those countries which had declared themselves as independent floaters in the IMF statistics were charaterised by a pronounced of floating and were actually heavily reacting to exchange rate movements, either in the form of an interest rate response, or by intervening in foreign exchange markets. The present analysis can be understood as an approach to develop a theoretical framework for this behaviour that - even though it is widely used in practice - has not attracted very much attention in monetary economics. In particular we would like to fill the gap that has recently been criticised by one of the few middle-ground economists, John Williamson, who argued that managed is not a regime with well-defined rules (Williamson, 2000, p. 47). Our approach is based on a standard open economy macro model typically employed for the analysis of monetary policy strategies. The consequences of independently and market determined exchange rates are evaluated in terms of a social welfare function, or, to be more precise, in terms of an intertemporal loss function containing a central bank's final targets output and inflation. We explicitly model the source of the observable fear of by questioning the basic assumption underlying most open economy macro models that the foreign exchange market is an efficient asset market with rational agents. We will show that both policy reactions to the fear of (an interest rate response to exchange rate movements which we call indirect floating, and sterilised interventions in the foreign exchange markets which we call direct floating) can be rationalised if we allow for deviations from the assumption of perfectly functioning foreign exchange markets and if we assume a central bank that takes these deviations into account and behaves so as to reach its final targets. In such a scenario with a high degree of uncertainty about the true model determining the exchange rate, the rationale for indirect is the monetary policy maker's quest for a robust interest rate policy rule that performs comparatively well across a range of alternative exchange rate models. We will show, however, that the strategy of indirect still bears the risk that the central bank's final targets might be negatively affected by the unpredictability of the true exchange rate behaviour. This is where the second policy measure comes into play. The use of sterilised foreign exchange market interventions to counter movements of market determined exchange rates can be rationalised by a central bank's effort to lower the risk of missing its final targets if it only has a single instrument at its disposal. We provide a theoretical model-based foundation of a strategy of direct in which the central bank targets, in addition to a short-term interest rate, the nominal exchange rate. In particular, we develop a rule for the instrument of intervening in the foreign exchange market that is based on the failure of foreign exchange market to guarantee a reliable relationship between the exchange rate and other fundamental variables.

Sterilized Foreign Exchange Market Interventions in a Chartist-Fundamentalist Exchange Rate Model

Sterilized foreign exchange market interventions are commonly dismissed by economists as an ineffective policy instrument. Nevertheless many central banks operating under independently floating exchange rates regimes are often engaged in sales and purchases of foreign exchange in order to manipulate the current value of their currencies. In this paper we argue that the skepticism of many economists can be ascribed to their orientation on fundamental-based, efficient-market exchange rate models. Given their weak empirical support, however, it is unreasonable to evaluate the effectiveness of sterilized foreign exchange interventions against the background of this class of models. Therefore, the purpose of this paper is to investigate the effectiveness of sterilized foreign exchange market interventions on the basis of a more suitable model. Using a chartist-fundamentalist model we show that central banks can influence exchange rates by using sterilized interventions. In particular, turning points occur earlier and exchange rate misalignments are substantially reduced.

Japanese and U.S. interventions in the yen/U.S. dollar market: estimating the monetary authorities’ reaction functions

This paper uses recently released official data on the foreign exchange market interventions of the Japanese monetary authorities in the yen/U.S. dollar market during the period 1991–2001 to examine the motivation for the intervention policy. We also compare the Japanese intervention policy with the U.S. intervention policy. Our results suggest that the Japanese authorities regularly responded to deviations of the yen/U.S. dollar exchange rate from a short-term and a long-term exchange rate target. By contrast, the U.S. authorities intervened only occasionally and seemed to have merely reinforced Japanese interventions.

The relative effectiveness of sterilized and non sterilized foreign exchange market interventions

This paper examines the impact of non sterilized and sterilized foreign exchange market operations on both the exchange rate and domestic interest rate within the context of a rational expectations portfolio balance model. The results show that non sterilized intervention will be more effective than sterilized intervention in affecting both the exchange rate and domestic interest rate. Both types of operations affect a market risk premium that is shown to be a function of relative asset supplies in the hands of the private sector. When domestic and foreign bonds are perfect substitutes, the risk premium vanishes and so to does the effectiveness of sterilized foreign exchange market interventions.

Foreign Exchange Market Intervention in Emerging Markets: Motives, Techniques and Implications

Foreign Exchange Market Intervention in Emerging Markets: Motives, Techniques and Implications

Capital Account Liberalization and the Real Exchange Rate in Chile

After the failure of the early 1980s, a second attempt at capital account liberalization was gradually carried out in Chile during the 1990s, this time in parallel with increased exchange rate flexibility. Capital account regulations were applied to support the independent monetary policy committed to the inflation target, while the exchange rate was quasi-pegged within a band that targeted the real exchange rate (RER). Still, the policy framework directed at stabilizing the RER appears to have been of limited effectiveness, with the surges and sudden-stops in capital flows playing an important role in RER dynamics. Foreign exchange market intervention appears not to have affected the RER while reserve requirement appears to have exerted a depreciating effect. Government spending and import tariffs, appear to be significant tools to moderate the real appreciation thus providing one additional reason for adopting a countercyclical fiscal policy and accelerating trade openness when a country is facing strong capital inflows.

Implications of Erm2 for Poland's Monetary Policy

This study proposes an extension to the inflation targeting framework for Poland that takes into consideration the exchange rate stability constraints imposed by the obligatory participation in the ERM2 on the path to the euro. The modified policy framework is based on targeting the differential between the domestic and the implicit euro area inflation forecasts. The exchange rate stability objective enters the central bank reaction function and is treated as an indicator variable. Adjustments of interest rates respond to changes in the relative inflation forecast, while foreign exchange market intervention is applied for the purpose of stabilizing the exchange rate. The dynamic market equilibrium exchange rate is ascertained by employing the Johanssen cointegration tests and the threshold generalized autoregressive heteroscedasticity model with the in-mean extension and generalized error distribution (TGARCH-M-GED).

Monetary Policy Adjustments on the Final Passage Towards the Euro

This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank's decisions. At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.

Implications of ERM2 for Poland's Monetary Policy

This study proposes an extension to the inflation targeting framework for Poland that takes into consideration the exchange rate stability constraints imposed by the obligatory participation in the ERM2 on the path to the euro. The modified policy framework is based on targeting the differential between the domestic and the implicit euro area inflation forecasts. The exchange rate stability objective enters the central bank reaction function and is treated as an indicator variable. Adjustments of interest rates respond to changes in the relative inflation forecast, while foreign exchange market intervention is applied for the purpose of stabilizing the exchange rate. The dynamic market equilibrium exchange rate is ascertained by employing the Johanssen cointegration tests and the threshold generalized autoregressive heteroscedasticity model with the in-mean extension and generalized error distribution (TGARCH-M-GED).

Sterilized Foreign Exchange Market Interventions in a Chartist-Fundamentalist Exchange Rate Model

Sterilisierte Devisenmarktinterventionen werden von den meisten Ökonomen als unwirksames wirtschaftspolitisches Instrument abgetan - und dies, obwohl viele Notenbanken regelmäßig davon Gebrauch machen. Im vorliegenden Beitrag argumentieren wir, dass diese Sichtweise aus der Verwendung von Wechselkursmodellen resultiert, die von effizienten Devisenmärkten ausgehen und in denen Wechselkursbewegungen durch Veränderungen von Fundamentaldaten erklärt werden. Aus empirischer Sicht lassen sich solche Wechselkursmodelle allerdings nur schwer bestätigen, weshalb eine Beurteilung der Wirksamkeit sterilisierter Devisenmarktinterventionen auf ihrer Basis unzulässig ist. Das Ziel des vorliegenden Beitrags ist es, die Wirksamkeit sterilisierter Devisenmarktinterventionen auf der Grundlage eines Chartisten-Fundamentalisten-Wechselkursmodells zu untersuchen. Wir zeigen, dass die Wendepunkte zwischen Auf- und Abwertungsphasen früher eintreten und dass Abweichungen vom fundamentalen Wechselkurs deutlich reduziert werden können.

Macroeconomic Effects of Capital Account Liberalization: the Case of Korea

AbstractThe macroeconomic effects of capital account liberalization in Korea are examined. Simple data analysis suggests that capital account liberalization substantially changed the nature and composition of capital flows. Based on the VAR model, the authors find the following stylized facts. First, after capital market liberalization, capital flows become less driven by current account imbalances and therefore become more autonomous. Second, capital account liberalization significantly changes the effects of capital flows on macroeconomic variables. Third, capital account liberalization is highly related to consumption and investment booms, and subsequent appreciation of nominal and real exchange rates, which leads to the current account worsening. Finally, there is strong evidence of sterilized foreign exchange market intervention in response to capital inflows.

Modeling the intensity of foreign exchange intervention activity

We suggest a count data model to study the intensity with which central banks conduct foreign exchange market intervention. The application to the Swiss interventions of the 1990s suggests that it yields important insight into the determinants of intervention policy.

Foreign exchange market intervention: implications of publicly announced and secret intervention for the euro exchange rate and its volatility

This paper explores the effects of foreign exchange market intervention by the European Central Bank and the Bank of Japan upon the conditional mean and variance of the euro–dollar and euro–yen exchange rates. To investigate whether the secrecy of intervention matters, we consider GARCH specifications revealing significant differences between publicly announced and secret interventions. While little evidence is found for the effectiveness of ECB intervention, the motivation is more clear for the Bank of Japan. Moreover Granger causality tests support a significant relationship between the bid-ask spread and conditional volatility only in the case of the JPY/EUR exchange rate indicating that intervention operations by the BoJ increased the uncertainty in the market.

The effects of Japanese foreign exchange market interventions on the yen/U.S. dollar exchange rate volatility

In previous empirical work, the link between the interventions of the Bank of Japan (BoJ) and exchange rate volatility has mainly been analyzed by using data on press reports of BoJ interventions. We use official intervention data for the period 1993–2000 that were released only recently by the BoJ. We find a positive link between the interventions of the BoJ and the volatility of the yen/U.S. dollar exchange rate. We also find that those BoJ interventions that were not reported in the financial press were positively correlated with exchange rate volatility.

Should Central Bankers Talk to the Foreign Exchange Market?

In this paper, we study the role of official statements and speeches given by authorities in charge of direct foreign exchange market interventions. We investigate the impact of commenting and confirming statements related to such interventions at a daily frequency for the two major foreign exchange markets over a quite long period (1989 onwards). Our results suggest that appropriate speeches related to the interventions can yield valuable signalling effects, either in terms of exchange rate levels or exchange rate volatility.

Modeling coordinated foreign exchange market interventions: The case of the Japanese and U.S. interventions in the 1990s

During the past thirty years, central banks often intervened in foreign exchange markets. Sometimes they carried out foreign exchange market interventions on a unilateral basis. However, central banks often coordinated their foreign exchange market interventions. We develop a quantitative reaction function model that renders it possible to study the factors that made central banks switch from unilateral to coordinated interventions. We apply our model to the intervention policies of the Japanese monetary authorities and the U.S. Federal Reserve in the yen/U.S. dollar market during the period 1991–2001. To this end, we use recently released official data on the foreign exchange market interventions of the Japanese monetary authorities. JEL no. F31, F33, G14, G15

On the determinants of “small” and “large” foreign exchange market interventions: The case of the Japanese interventions in the 1990s

During the past 30 years, central banks have often intervened in foreign exchange markets, and the magnitude of their foreign exchange market interventions has varied widely. We develop a quantitative reaction function model that renders it possible to examine the determinants of “small” and “large” interventions. We apply the model to analyzing the intervention policy of the Japanese monetary authorities (JMA) in the yen/U.S. dollar market during the period from 1991 through 2001. To this end, we use recently released official data on the foreign exchange market interventions of the JMA. We find that the JMA tended to conduct large interventions when the yen/U.S. dollar exchange rate drifted away from an “implicit target exchange rate.”

The accuracy of press reports regarding the foreign exchange interventions of the Bank of Japan

This paper presents evidence on the accuracy of press reports regarding the foreign exchange market interventions conducted by the Bank of Japan (BoJ) between January 1995 and December 1999. We find that the reports of interventions in the financial press are a relatively inaccurate indicator for the actual interventions of the BoJ. We also find that the accuracy of press reports of BoJ interventions is higher for those interventions that were carried out jointly by the BoJ and the Federal Reserve.

Effectiveness of Official Daily Foreign Exchange Market Intervention Operations in Japan

Japanese official intervention in the foreign exchange market is of by far the largest magnitude in the world, despite little or no evidence that it is effective in moving exchange rates. Up until recently, however, official data on intervention has not been available for Japan. This paper investigates the effectiveness of intervention using recently published official daily data and an event study methodology. The event study better fits the stochastic properties of intervention and exchange rate data, i.e. intense and sporadic bursts of intervention activity juxtaposed against a yen/dollar rate continuously changing, than standard time-series approaches. Focusing on daily Japanese and US official intervention operations, we identify separate intervention episodes and analyze the subsequent effect on the exchange rate. Using the non-parametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange rate in the short-run (less than one month). This result holds even when intervention is not associated with (simultaneous) interest rate changes, whether or not intervention is secret (in the sense of no official reports or rumors of intervention reported over the newswires), and against other robustness checks. Large-scale (amounts over $1 billion) intervention, coordinated with the Bank of Japan and the Federal Reserve working in unison, give the highest success rate. During the period that the Bank of Japan has reduced interbank rates to 0.5 percent and below (from September 1995), however, only one intervention operation has been coordinated with the Fed and the success rate has been correspondingly low.

Foreign exchange market intervention in two small open economies: the Canadian and Australian experience

We examine intervention by the Bank of Canada and the Reserve Bank of Australia for daily data from 1989 to 1998. Both central banks intervene in response to excessive exchange rate volatility and uncertainty. Volatility is the implied volatility of foreign currency futures options. Uncertainty is the kurtosis of the implied risk-neutral probability density functions. We also examine the impact of inflation targets. Unlike other studies we also consider commodity futures prices. These turn out to help explain the effectiveness of intervention. Central bank intervention was largely unsuccessful in both countries though volatility and kurtosis were modestly affected.