Effectiveness of Foreign Exchange Market Interventions

  • Silke Fabian
Part of the Handeln und Entscheiden in komplexen ökonomischen Situationen book series (HANDELN, volume 9)


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.


Exchange Rate Monetary Policy Central Bank Foreign Exchange Risk Premium 
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  1. 1.
    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].Google Scholar
  2. 2.
    An alternative objective could be the monitoring of international reserve assets, see for example Hamada [1976], Jurgensen [1982] and Taylor[199l].Google Scholar
  3. 3.
    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.Google Scholar
  4. 4.
    Of course, there may be indirect channels. The model in Chapter 3 allows for price responses that affect the interest differential.Google Scholar
  5. 5.
    A non-zero risk premium also arises in consumption-based asset pricing models (see Obstfeldt [1990, pp. 214–17]).Google Scholar
  6. 6.
    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.Google Scholar
  7. 7.
    Similar concerns have been expressed by US Secretary of State James Baker in early 1985, see FAZ [Feb. 18 1985].Google Scholar
  8. 8.
    Uncovered interest parity is considered in the model of the following chapters. If there is risk aversion, there will be partial effects on st and RP t (see also Taylor [1991]).Google Scholar
  9. 9.
    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.Google Scholar
  10. 10.
    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.Google Scholar
  11. 11.
    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.Google Scholar
  12. 12.
    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.Google Scholar
  13. 13.
    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.Google Scholar
  14. 14.
    This is supported by Taylor [1991] and Jurgensen [1982, fig. 48], for example.Google Scholar
  15. 15.
    Note that in the case of rational speculative bubbles interventions bear no ‘‘news”, and this is not a strict signalling example.Google Scholar
  16. 16.
    Moreover, the other situations may be inferred from the analysis as well.Google Scholar

Copyright information

© Physica-Verlag Heidelberg 1993

Authors and Affiliations

  • Silke Fabian
    • 1
  1. 1.Department of EconomicsGeorge Washington UniversityUSA

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