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On the Effectiveness of Central Bank Intervention in the Foreign Exchange Market: The Case of Slovakia, 1999–2007

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Abstract

Based on intraday high-frequency data, this paper investigates the effect of sterilized interventions on the Slovak koruna/euro exchange rate for different time windows during a period that coincides with Slovakia’s preparation for EU accession and euro adoption. Results confirm a significant relationship between intervention and exchange rate change. The maximum effect of intervention is reflected in the exchange rate change within a couple of hours, and the effect over longer time windows weakens only gradually. The initial impact of sale interventions is stronger than that of purchase interventions.

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Fig. 1

Note: At the time of ERM II entry on November 25, 2005, the central parity was set at the then-prevailing market rate of Sk 38.4550 per euro. On March 19, 2007, the central parity was revalued to Sk 35.4424. The central parity was revalued for the second time in May 2008 to Sk 30.1260. The revised parity was subsequently adopted as the final conversion rate in July 2008

Fig. 2
Fig. 3
Fig. 4

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Notes

  1. Notable country-specific studies include Adler and Tovar (2011) for a select group of 15 countries; Beattie and Fillion (1999), Fatum (2008) and Fatum and King (2005) for Canada; Chang and Taylor (1998), Fatum and Hutchison (2006), Hoshikawa (2008), Ito (2002), Kim (2007) and Rasmus and Hutchison (2006) for Japan; Disyatat and Galati (2005), Égert and Komárek (2006), Geršl (2006) and Geršl and Holub (2006) for the Czech Republic; Fischer and Zurlinden (1999) and Payne and Vitale (2003) for Switzerland; Fuentes et al. (2014) for four Latin American countries, Lahura and Vega (2013) for Peru, and Tapia and Tokman (2004) and Tapia et al. (2004) for Chile; Guimarães and Karacadağ (2004) for Mexico and Turkey; Kearns and Rigobon (2005) for Australia and Japan; Kim et al. (2000) for Australia; Kohlscheen and Andrade (2014) for Brazil; and Rogers and Siklos (2003) for Australia and Canada.

  2. Examples of studies that obtained coefficients with the wrong sign include Kaminsky and Lewis (1996) and Kim et al. (2000).

  3. See, for example, Fuentes et al. (2014) for Chile, Columbia, Mexico and Peru; Kohlscheen and Andrade (2014) for Brazil; Lahura and Vega (2013) for Peru; Payne and Vitale (2003) for Switzerland; and Tapia and Tokman (2004) and Tapia et al. (2004) for Chile.

  4. Since the National Bank of Slovakia relied on multiple instruments of policy and sterilized interventions were not the only monetary policy instrument, it would be difficult to disentangle the influence of the different channels.

  5. See the Annual Report of the National Bank of Slovakia for the years 1999–2002. http://www.nbs.sk/_img/Documents/_Publikacie/AnnualReport/ARNBS00.pdf.

  6. See the Annual Report of the National Bank of Slovakia for the years 2003 onward.

  7. Although a ± 15% exchange rate band around the central parity seemingly provided some flexibility, it was not clear in advance how the European Commission (EC) and European Central Bank (ECB) would interpret exchange rate stability. This issue was frequently discussed by the NBS staff with the EC and ECB staff. On this basis, the NBS staff considered it likely that real exchange rate appreciation generated by structural factors would be taken into account in the assessment of exchange rate stability. It was also believed by the NBS staff and the market that there was an informal lower limit of 2.25% on the depreciation side of the ERM II band.

  8. This was communicated to the authors by a NBS Board member who was in charge of foreign exchange operations.

  9. The daily exchange rate in Fig. 1 is represented by the end of day rate.

  10. At the time of ERM II entry in November 2005, the central parity was set at the then-prevailing market rate of Sk 38.4550 per euro. In March 2007, the central parity was revalued by 8.5% to Sk 35.4424. The central parity was revalued for the second time in May 2008 to Sk 30.1260 per euro, a rate which was higher than the prevailing market rate and corresponded to the top edge of the ± 15% exchange rate band under the previous central parity. The revised parity was subsequently adopted as the final conversion rate in July. Thus, the final conversion rate was some 22% more appreciated than the central parity set at time of ERM II entry.

  11. The average of the bid/ask spread depends on the nature of the quote submitted. Not all quotes were submitted with both a bid and ask. If only one of these values was available, we took this value as the average, whereas if both were available, the average was calculated as the uniformly weighted average of the bid and ask.

  12. For certain time windows, it is impossible to divide the day evenly. For instance, for the time window of 2 h and 50 min the day cannot be divided evenly as 1440 (the number of minutes in a day) divided by 170 (the number of minutes in a 2-h and 50-min time interval) is 8.4706. In these instances, the day was segmented in the normal way, except for the last time window which was composed of the remaining minutes in the day. Thus, for the 2-h and 50-min time interval, the day is broken up beginning at 00:00:00 into eight 170-min time intervals and one 80-min time interval. This is not an unreasonable assumption because of the 1099 intervention trades, only two intervention trades occurred after 16:00:00.

  13. In earlier studies, the exchange rate variations have been measured over time intervals of varying lengths: 5 min (Fuentes et al. 2014 for Peru and Mexico; and Lahura and Vega 2013 for Peru), 10 min (Tapia and Tokman 2004 for Chile), 15 min (Kohlscheen and Andrade 2014 for Brazil; and Payne and Vitale 2003 for Switzerland), and 20 min (Fuentes et al. 2014 for Chile; and Tapia and Tokman 2004 for Chile). In the study by Kohlscheen and Andrade (2014), the time window goes up to 90 min after the event. Fuentes et al. (2014) also report descriptive statistics of the transactions data for the 5-min, 20-min, 1-h, 6-h, and 24-h time intervals.

  14. Adler and Tovar (2011) and Tapia and Tokman (2004) also have a baseline specification in which the intervention volume is the only explanatory variable.

  15. This is the official classification of the monetary framework. See the various issues of the Annual Report of the National Bank of Slovakia. http://www.nbs.sk/_img/Documents/_Publikacie/AnnualReport/ARNBS00.pdf.

  16. Post-regression diagnostic tests revealed that residuals of a majority of time windows passed the tests for omitted variable, serial correlation, and multicollinearity but did not pass the test of heteroscedasticity. The Newey–West standard errors are robust to both heteroscedasticity and serial correlation and are often termed heteroscedasticity- and autocorrelation-consistent (HAC) standard errors.

  17. It is possible that interventions could have an effect on the exchange rate during a specific time window that is not captured by looking at the difference in the exchange rate at the beginning and the end of the time window. Perhaps, this could explain the variations in the coefficients for different time windows shown in Fig. 2.

  18. The results are not reported in tables but are available from the corresponding author.

  19. For example, the computed F-ratios are 5.30 (p = 0.0050) for the 1-min window; 9.84 (p = 0.0001) for the 5-min window; and 9.33 (p = 0.0001) for the 10-min window.

  20. We are grateful to one of the anonymous referees for pointing out that the story would be completely different under a unilateral commitment (like in the Czech Republic) to intervene with no volume limits against appreciation at some exchange rate level.

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Acknowledgements

At the time of writing this paper, Biswajit Banerjee was Chief Economist at the Bank of Slovenia. William O. Riiska, Jr., contributed to the paper when he was at Haverford College. Comments received from five anonymous referees and the editor have contributed to substantial strengthening of the paper. The views expressed in this paper are those of the authors and do not necessarily represent the views of the institutions to which they are affiliated.

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Authors and Affiliations

  1. Ministry of Finance of the Slovak Republic, Štefanovičová 5, 81782, Bratislava, Slovak Republic

    Biswajit Banerjee

  2. Department of Economics, Ashoka University, Sonepat, Haryana, 131029, India

    Biswajit Banerjee

  3. National Bank of Slovakia, Imricha Karvaša 1, 81325, Bratislava, Slovak Republic

    Juraj Zeman

  4. Council for Budget Responsibility, Imricha Karvaša 1, 81325, Bratislava, Slovak Republic

    Ľudovít Ódor

  5. Hutchin Hill Capital, 142 West 57th Street, New York, NY, 10019, USA

    William O. Riiska Jr.

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Banerjee, B., Zeman, J., Ódor, Ľ. et al. On the Effectiveness of Central Bank Intervention in the Foreign Exchange Market: The Case of Slovakia, 1999–2007. Comp Econ Stud 60, 442–474 (2018). https://doi.org/10.1057/s41294-017-0039-z

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