Abstract
This paper analyzes an exchange rate policy game between a central bank and rational speculators under symmetric information. The central bank tries to counteract shocks to the exchange rate by means of sterilized intervention working through the expectations channel. Private speculators resist being fooled. They anticipate the interventions. An “intervention bias” results with an inefficiently high equilibrium volume of intervention which does not reduce the impact of shocks to the exchange rate. The model implies that the more independent the central bank the smaller and the more consistent the intervention efforts. An empirical illustration lends some support to the model.
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This paper was written while I was with Tilburg University, The Netherlands. The views expressed are my own and do not necessarily represent those of the IMF. I am grateful to Alex Cukierman, Sylvester Eijffinger, Harry Huizinga, Eric Schaling, Jacques Sijben, an anonymous referee and seminar participants at the Federal Reserve Bank of New York, the International Finance Division of the Board of Governors of the Federal Reserve System, the 9th Annual Meeting of the European Economic Association in Maastricht and CentER, Tilburg University for comments and suggestions.
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Almekinders, G.J. The political economy of central bank intervention. Public Choice 88, 127–146 (1996). https://doi.org/10.1007/BF00130414
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DOI: https://doi.org/10.1007/BF00130414