Abstract
This chapter discusses the mechanisms by which interventions might affect exchange rates and thus be used as an effective policy instrument. At the outset, a few definitions are in order: Formally, official interventions refer to the purchase or sale of foreign exchange by the monetary authorities.1 In general the objective of such operations is to influence exchange rates.2 To be precise, “monetary authorities” include the central bank and — depending on the country-specific circumstances — the relevant government institutions that buy and sell foreign exchange. If not indicated otherwise, we will abstract from the latter and simply refer to the central bank as the monetary authority.
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Note that this conventional definition excludes passive intervention and interest earnings on international reserve assets which some authors include in a wider definition of the term. For example, Jurgensen [1982] consider all changes in the net foreign currency position of the monetary authorities as interventions. Moreover, a wide array of assets qualify as foreign exchange. For a detailed description see Bryant [1980, chapter 20].
An alternative objective could be the monitoring of international reserve assets, see for example Hamada [1976], Jurgensen [1982] and Taylor[199l].
But for the Bundesbank interventions during 1975–81 Neumann [1984] finds a sterilization coefficient lower than one. He thus challenges Obstfeldt’s [1983] results of nearly complete neutralization in this same time period.
Of course, there may be indirect channels. The model in Chapter 3 allows for price responses that affect the interest differential.
A non-zero risk premium also arises in consumption-based asset pricing models (see Obstfeldt [1990, pp. 214–17]).
Under exchange market efficiency, uncovered interest parity implies the equivalence of expected and forward exchange rates. The latter are observable and used in the estimation. We come back to this joint hypotheses in the context of testing for the rationality of expectations in section 2.4.
Similar concerns have been expressed by US Secretary of State James Baker in early 1985, see FAZ [Feb. 18 1985].
Uncovered interest parity is considered in the model of the following chapters. If there is risk aversion, there will be partial effects on s t and RP t (see also Taylor [1991]).
Rieke [1984] and Emminger [1986, p. 315] point out that interventions may be stabilizing even if central banks thereby incur losses. Moreover, the realization of losses or profits clearly depends also on the time frame of analysis.
But this does not rule out market inefficiency as such. Indeed, in section 2.4. non-rational expectations are explicitly introduced as an integral part of the model.
This may generate reputational problems in the future, when the central bank carries out a monetary policy that had not been perceived as an intervention signal by the private sector. Accompanying interventions by policy announcements may insure against such effects.
If there is none, the question is how exchange rates should be affected, if neither a monetary policy change is undertaken today (non-sterilized interventions), nor signalled for the future. Thus a market’s expectation of policy change upon observing sterilized interventions appears a very rational response.
The importance of the assessment of market expectations prior to intervening has been pointed out to me by Professor Dr. H. Hesse, president of Landeszentralbank in der freien Hansestadt Bremen, in Niedersachsen und Sachsen-Anhalt, Germany.
This is supported by Taylor [1991] and Jurgensen [1982, fig. 48], for example.
Note that in the case of rational speculative bubbles interventions bear no ‘‘news”, and this is not a strict signalling example.
Moreover, the other situations may be inferred from the analysis as well.
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© 1993 Physica-Verlag Heidelberg
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Fabian, S. (1993). Effectiveness of Foreign Exchange Market Interventions. In: Exchange Rate Management in Interdependent Economies. Handeln und Entscheiden in komplexen ökonomischen Situationen, vol 9. Physica-Verlag HD. https://doi.org/10.1007/978-3-642-50029-9_2
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DOI: https://doi.org/10.1007/978-3-642-50029-9_2
Publisher Name: Physica-Verlag HD
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