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The Moses effect: can central banks really guide foreign exchange markets?

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Abstract

Central banks seek to guide the foreign exchange market through interventions. However, the success of the central bank in guiding the forex markets, much like the biblical Moses, depends on the differing perceptions and resulting bid–ask spreads of market participants following intervention. Using high-frequency data, we study the behaviour of exchange rate volatility (as reflected in change in bid–ask spreads) following intervention by Reserve Bank of India, India’s central bank. We find that intervention increases the probability of volatility being in higher ranges. Event-wise analysis shows an increase in volatility in shorter time frames and a decrease in volatility over the longer time frame of the day, following intervention.

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Notes

  1. The intervention through select public sector banks is referred to as ‘indirect intervention’ in RBI (2013). The term ‘indirect intervention’ is used much more broadly in the literature (see Neely 2000) to refer to policy changes (capital and exchange controls) as well as intervention through ‘undisclosed foreign exchange accounts held at commercial banks’ (Neely Ibid: p.26). Policy changes would impact exchange rates in a very different way than the intervention carried out through select banks. We therefore refer to the interventions carried out though PSBs as ‘undisclosed or secret interventions’.

  2. For example: News Report from Cogencis: 11th November, 2016, 10.09 am: India Rupee: Cut some losses on DLR sales by PSU BKS likely for RBI. It is reported that public sector banks (likely on behalf of RBI) was in the market selling dollars (at 67.15 rupees per dollar).

  3. In the intra-day framework, we consider only intervention through purchase and sale of foreign currency through PSBs, as reported by news, referred to in this paper as ‘undisclosed or secret intervention’. Indirect intervention (through policy changes) is not part of our model as it is unlikely to have much impact in the intra-day time frame.

  4. Technical analysis refers to a set of qualitative or quantitative indicators that can generate trading signals. See Menkoff & Taylor (2007) for a comprehensive review of literature on technical analysis strategies and their profitability.

  5. Intervention to reverse the exchange rate direction is referred to as leaning against the wind (LAW).

  6. Cogencis Information Services Ltd, (2016).

  7. Cogencis Information Services Ltd, Ibid. For majority of news given by Cogencis, and especially the intervention news, the journalist/contributor’s name is mentioned in news item.

  8. The lack of availability of public data on the precise timing of intervention contributes to this problem. For example, Neely (2005) points out only Switzerland shares the exact timing of intervention.

  9. We recognize the loss of information from the conversion of continuous to discreet (categorical) variable but the differentiation into high medium and low volatility buckets is crucial for the Logit analysis used in the paper. To keep the information loss as minimal we increase the number of categories (three) (Pasta, 2009).

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Acknowledgements

I thank the editor and anonymous referee/s for their valuable comments during the review process. The views on this article correspond to the author and do not reflect those of institution to which the author belongs to. Errors, if any, are my responsibility.

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  1. Money, International Banking, and Finance, National Institute of Bank Management, Pune, India

    Smita Roy Trivedi

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Roy Trivedi, S. The Moses effect: can central banks really guide foreign exchange markets?. Empir Econ 58, 2837–2865 (2020). https://doi.org/10.1007/s00181-019-01671-y

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