Foreign Exchange Intervention

10 Key excerpts on "Foreign Exchange Intervention"

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  eBook - ePub

  The Development of International Monetary Policy

  • Christopher Warburton(Author)
  • 2017(Publication Date)
  • Taylor & Francis

    (Publisher)

  7  Intervention in foreign exchange markets and the future of fiat money

  In many ways, this chapter is an extension of Chapter 2 . It analyses the rationale for intervention in foreign exchange markets and the conditions under which intervention can be manipulatory. It also evaluates the viability of fiat money in the distant future, given the emergence of complementary electronic currency. The fundamental properties of money and the relevance of such properties are discussed.

  What are Foreign Exchange Interventions? Foreign Exchange Interventions are the purchases and sales of foreign currency in foreign exchange markets to attain specific or multiple macroeconomic objectives. Foreign exchange markets are networks of financial institutions and brokers in which individuals, businesses, banks, and governments buy and sell the currencies of different countries. Foreign exchange market participants are generally interested in financing international trade, investing or doing business abroad, or speculating on currency price movements. Different currencies are traded on a daily basis to the tune of about $2 trillion in the FX market around the world.

  There are two primary types of transactions in the FX market: (a) spot transactions (agreement to buy or sell currency at the current exchange rate) to be settled in about two days, and (b) forward transactions in which traders agree to buy and sell currencies at predetermined exchange rates for settlement in at least three days. Businesses use forward transactions to reduce their exposures to exchange rate risk.

  Intervention in foreign exchange market is nothing new, but its excesses can be disruptive. Some of the fundamental and concerted reasons for regulating monetary policy were presented in Chapter 2 , paramount of which is the effort to prevent macroeconomic destabilisation. Invariably, the delictual effect of intervention is less precise because sovereign nations are legally permitted to ensure the stability of their economies as long as their methods do not threaten global financial stability. Recall the lawful customary and conventional monetary sovereign rights that were discussed in Chapter 2

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  International Financial Management

  • Geert Bekaert, Robert Hodrick(Authors)
  • 2017(Publication Date)
  • Cambridge University Press

    (Publisher)

  5.3 Flexible Exchange Rate Systems 187 5.3 Flexible Exchange Rate Systems Although the central banks of the major developed countries mostly let competitive market forces determine the values of their exchange rates, they nonetheless have a variety of tools at their disposal to influence the path of exchange rates. For example, they can use domestic monetary policy (by varying the money supply or interest rates under their control); they can attempt to restrict capital movements; or they can tax or subsidize international trade to influence the demand for foreign currency. We will come back to these alternative tools later on in this chapter. Here we focus on direct Foreign Exchange Intervention – that is, the sale or purchase of foreign assets against domestic assets by the central bank. The Effects of Central Bank Interventions Despite their prevalence, Foreign Exchange Interventions are a controversial policy option for central banks. In one view, intervention policy is not only ineffective in influencing the level of the exchange rate, but it is viewed as dangerous because it can increase foreign exchange volatility. Nobel Laureate Milton Friedman (1953) viewed interventions as ineffective and a waste of taxpayers’ money. Others argue that intervention operations can influence the level of the exchange rate and can “calm disorderly markets,” thereby decreasing volatility. money multiplier. From 2006 to 2012, reserve requirements for the commercial banks were raised multiple times, from less than 8.0% to 21.5%. All the while, China main- tained a fairly stable exchange rate, letting the yuan appreciate in a controlled manner. 7 When the Chinese government devalued the renminbi in August 2015, it confirmed a new trilemma reality for China. China has cautiously continued a process of reforming and opening up its capital markets, including letting private Chinese citizens invest some of their savings abroad, to a limit of $50,000 per person.

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  Regional Economic Outlook, April 2011, Western Hemisphere : Watching Out for Overheating

  • International Monetary Fund. Western Hemisphere Dept.(Author)
  • 2011(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  Figure 3.2 . Intervention has nearly always been in the same direction, but varies greatly in both frequency and intensity across countries. Intervention has been accompanied by exchange rate appreciation in many cases.

  Source: IMF staff calculations on the basis of central bank data.

  Note: Latin America includes Costa Rica, Guatemala, and Uruguay. Positive values of intervention refer to purchases, whereas negative values refer to sales. For the sake of completeness, both purchases and sales are depicted. Upward movements of the exchange rate correspond to depreciations. Arrows on the axis denote that the scale has been changed relative to previous and subsequent panels.

  1 Intervention measured as a percentage of the average annual GDP between 2004 and 2010.

  2 Some FX operations conducted by Banco de Mexico may not be considered as intervention and show how difficult it is to have a proper definition. In particular, prior to the crisis, the central bank was selling, according to an announced rule, exactly half of the increase in net reserves, which reflected Pemex and the federal government’s law-mandated transfers of their FX receipts to the central bank. The policy adopted by the foreign exchange commission was to reduce the pace of accumulation of international reserves. Actual purchases (through options) have taken place only since March 2010. Option auction data reported.

  3 Simple averages.

  Passage contains an image

  3.3. Modalities of Intervention

  In general, knowledge of the manner in which central banks intervene in FX markets is limited. This is partly because many central banks withhold such information, but also because the country information that is available is dispersed, and the literature on intervention tends to focus on one country at a time. Some studies have examined intervention practices through surveys, aiming at drawing lessons on best practices (Neely, 2008 , 2001; Bank for International Settlements, 2005 ; Shogo and others, 2006 ; and Canales-Kriljenko, 2003 ).7

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  Strained Relations

  US Foreign-Exchange Operations and Monetary Policy in the Twentieth Century

  • Michael D. Bordo, Owen F. Humpage, Anna J. Schwartz(Authors)
  • 2015(Publication Date)
  • University of Chicago Press

    (Publisher)

  In the short run, intervention often generates losses, a point that Goodhart and Hesse (1993) also illustrate. Hence, it is possible that technical traders profit against central banks in the short run while central banks profit in the long term. This raises questions about the effect that sustained intervention might have on the functioning of private foreign-exchange markets. 25 1.7   Road Map This chapter has presented background material on foreign-exchange intervention and on the US institutional framework for that intervention. The remainder of this book explains how theories of intervention and institutional arrangements evolved in the United States, primarily during the twentieth century. The key concern is how these developments interacted with monetary policy. As chapter 2 explains, precedents for modern foreign-exchange-market operations are found in European experience with the classical gold standard, but they quickly grew and developed after World War I as countries first attempted to return to the gold standard and then reacted to the Great Depression. European central banks under the classical gold standard often bent the “rules of the game” through discount policies and gold devices. These were early exchange-market operations. Some European central banks held foreign-exchange reserves and stabilized their exchange rates within the gold points through intervention. Chapter 2 illustrates early uses of secrecy, sterilization, and forward transactions—all of which become important characteristics of modern interventions. The chapter also discusses the establishment of the British Exchange Equalisation Account, which directly intervened in the foreign-exchange market. American antecedents also aided the development of foreign-exchange operations in the United States. Chapter 2 explains the rise of private firms that specialized in the spatial and temporal arbitrage of sterling bills and related instruments

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  Multinational Financial Management

  • Alan C. Shapiro, Paul Hanouna(Authors)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  In order to achieve certain economic or political objectives, governments often intervene in the currency markets to affect the exchange rate. Although the mechanics of such interventions vary, the general purpose of each variant is basically the same: to increase the market demand for one currency by increasing the market supply of another. Alternatively, the government can control the exchange rate directly by setting a price for its currency and then restricting access to the foreign exchange market. A critical factor that helps explain the volatility of exchange rates is that with a fiat money, there is no anchor to a currency’s value, nothing around which beliefs can coalesce. In this situation, in which people are unsure of what to expect, any new piece of information can dramatically alter their beliefs. Thus, if the underlying domestic economic policies are unstable, exchange rates will be volatile as traders react to new information. Mini-Case: Argentina’s Bold Currency Experiment and Its Demise Argentina, once the world’s seventh-largest economy, has long been considered one of Latin America’s worst basket cases. Starting with Juan Peron, who was first elected president in 1946, and for decades after, profligate government spending financed by a compliant central bank that printed money to cover the chronic budget deficits had triggered a vicious cycle of inflation and devaluation. High taxes and excessive controls compounded Argentina’s woes and led to an overregulated, arthritic economy. How- ever, in 1991, after the country had suffered nearly 50 years of economic mismanagement, President Carlos Menem and his fourth Minister of Economy, Domingo Cavallo, launched the Convertibility Act.

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  The Economics of Exchange Rates

  • Lucio Sarno, Mark P. Taylor(Authors)
  • 2003(Publication Date)
  • Cambridge University Press

    (Publisher)

  (1991), ‘Foreign Exchange Market Intervention and Domestic Monetary Control in Japan, 1973– 1989’, Japan and the World Economy , 3, pp. 147–80. 244 The economics of exchange rates Taylor, D. (1982), ‘Official Intervention in the Foreign Exchange Market, or, Bet Against the Central Bank’, Journal of Political Economy , 90, pp. 356–68. Taylor, M.P. (1995), ‘The Economics of Exchange Rates’, Journal of Economic Literature , 83, pp. 13–47. Taylor, M.P. and H.L. Allen (1992), ‘The Use of Technical Analysis in the Foreign Exchange Market’, Journal of International Money and Finance , 11, pp. 304–14. Tobin, J. (1969), ‘A General Equilibrium Approach to Monetary Theory’, Journal of Money, Credit, and Banking , 1, pp. 15–29. Tryon, R.W. (1983), Small Empirical Models of Exchange Market Intervention: A Review of the Liter-ature , Staff Studies 134, Board of Governors of the Federal Reserve System, Washington, D.C. Tullio, G. and V. Natarov (1999), ‘Daily Interventions by the Central Bank of Russia in the Treasury Bill Market’, International Journal of Finance and Economics , 4, pp. 229–42. Tullio, G. and M. Ronci (1997), ‘Central Bank Autonomy, the Exchange Rate Constraint and Inflation: The Case of Italy’, Open Economies Review , 1, pp. 31–49. Turnovsky, S.J. (1987), ‘Optimal Monetary Policy and Wage Indexation Under Alternative Distur-bances and Information Structures’, Journal of Money, Credit, and Banking , 19, pp. 157–80. von Hagen, J. (1989), ‘Monetary Targeting with Exchange Rate Constraints: The Bundesbank in the 1980s’, Federal Reserve Bank of St Louis Review , 71, pp. 53–69. Wadhwani, S. (2000), ‘The Exchange Rate and the Monetary Policy Committee: What Can We Do?’, Speech to the Senior Business Forum at the Centre for Economic Performance, 31 May. Wallich, H. (1984), ‘Institutional Cooperation in the World Economy’, in J. Frenkel and M. Mussa (eds.), The World Economic System: Performance and Prospects , Dover N.H.: Auburn House, pp.

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  Information Spillovers and Market Integration in International Finance

  Empirical Analyses

  • Suk-Joong Kim(Author)
  • 2017(Publication Date)
  • WSPC

    (Publisher)

  However, official interventions by the BOJ were ineffective at best and market disturbing at worst prior to 1995. Specifically, a Yen purchase (sale) was associated with a Yen depreciation (appreciation) on the day of intervention which might lead to an erroneous conclusion of intervention ineffectiveness. There has also been some evidence that interventions were associated with an increase in foreign exchange volatility, and consequently, had an adverse effect of destabilising the market (Beine, 2004; Nagayasu, 2004; Frenkel et al., 2005). Over recent years, the BOJ has been claimed to have intervened mostly in a secret manner. Beine and Bernal (2007) report that about 80% of total transactions during 2003–2004 were not publicly known at the time of intervention. A secret intervention is executed in such a way that allows a central bank to influence the exchange rate without sending any signal about its presence in the market. Previous literature has suggested that a central bank will opt to intervene covertly for many reasons. First, there may be occasions where there is a need to intervene to correct a current trend in exchange rate movements but such a move would contradict the current monetary policy objective. Such a misalignment in policy objectives would require a secret Foreign Exchange Intervention so as to achieve the foreign exchange aim without losing a monetary policy credibility (Chiu, 2003). Second, if the bank experiences a low level of credibility or there is a record of past failures in influencing the currency (Dominguez and Frankel, 1993), publicly known interventions, unless they are substantially large and repeated (and possibly coordinated with other central banks) may not achieve desired outcomes as market will not value the information contained in the intervention

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  Demystifying Global Macroeconomics

  • John E. Marthinsen(Author)
  • 2020(Publication Date)
  • De Gruyter

    (Publisher)

  Famous currency depreciations, such as in Mexico (1994), Thailand (1997), and Argentina (2002), were caused by these countries ’ central banks depleting their foreign currency reserves, which were used to support overvalued currencies. Figure 16.20 shows the effect of intervention by the Bank of Mexico to raise the value of the peso. An increase in demand from D 1 to D 2 raises the value of the peso from FX 1 to FX 2 (i.e., from A to B), and the equilibrium quantity of pesos rises from MXN A to MXN B . Foreign Exchange Intervention and the Monetary Base When a central bank intervenes in the foreign exchange market, it changes the domestic monetary base. Suppose the Bank of Mexico intervened to raise the value of the peso. To accomplish this goal, it would sell its dollar reserves and purchase pesos. Figure 16.21 shows that these foreign exchange market pur-chases remove pesos from Mexican banks ’ reserves and, thereby, reduce the Mexican monetary base. The effect of these transactions on the U.S. monetary base depends on where the Bank of Mexico held its dollar reserves. If they were held on deposit at the U.S. U.S. Federal Reserve, then this intervention would raise the U.S. monetary base, as dollars flowed into banks (below the line). If they were already held 16 For nations with relatively undeveloped capital markets, another reason to use the foreign exchange markets is to change their domestic monetary bases. What Causes Exchange Rates to Change? 481 in banks (below the line), then the U.S. monetary base would not change. Figure 16.21 shows the effects if the reserves were held at the Fed. The Rest of the Story International Exchange Rate Systems What type of exchange rate system does your home country use? Each year, the International Monetary Fund lists the currency regimes for its 189 member na-tions. 17 Evident is the diversity of systems, which reflects controversies over the merits and weaknesses of fixed versus flexible exchange rates.

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  An Exchange Rate History of the United Kingdom

  1945–1992

  • Alain Naef(Author)
  • 2022(Publication Date)
  • Cambridge University Press

    (Publisher)

  Coombs, The Arena of International Finance (New York: Wiley, 1976). 2 Michael D. Bordo, Owen F. Humpage and Anna J. Schwartz, Strained Relations: US Foreign-Exchange Operations and Monetary Policy in the Twentieth Century (Chicago, IL: University of Chicago Press, 2015). 46 system. British intervention has received no more than sporadic attention in the literature. Bordo et al. wrote the first econometric paper on foreign exchange market intervention for the United Kingdom during the sterling crises between 1964 and 1967. 3 They argue that Britain maintained the peg with the dollar thanks to loans and external help, such as swap contracts and international rescue packages. The Bank mainly intervened in the dollar/sterling market, with the dealers’ reports registering negligible intervention in the Canadian dollar and French franc in the early 1950s and sporadic mention of Deutschmark intervention in 1957. 4 Foreign Exchange InterventionS The Bank of England was active in the market every day, as recorded in the dealers’ reports. The goal of intervention was two-fold. The first goal was to keep the exchange rate within the Bretton Woods bands. For example, bands were $2.78–2.82/£ in 1949–67. The second goal was to avoid ‘undue fluctuations in the exchange value of sterling’. 5 This second point derives from the Finance Act of 1932 and is a woolly definition of maintaining ‘orderly’ markets. It can be understood as foreign exchange market house- keeping. The concept of ‘orderly markets’ was not based on any metric or model and is unclear. The goal of keeping markets tidy was a recurring theme at the Bank. It can also be found in the gold market (see Chapter 5) and the money market. 6 For the money market, Capie notes how the Bank ‘tried to influence expectations and engaged in psychological warfare’. It also gave ‘dark hints and by a variety of means nudged or indicated or otherwise tried to suggest the outcome it wanted’.

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  Renminbi from Marketization to Internationalization

  • Zhongxia Jin, Yue Zhao, Haobin Wang(Authors)
  • 2022(Publication Date)
  • Routledge

    (Publisher)

  1 The Macroeconomic Impact of Foreign Exchange InterventionCross-Country Empirical Studies

  DOI: 10.4324/9781003305668-1

  The Macroeconomic Impact of Foreign Exchange Intervention: Background and Methodology

  Mainstream views regarding the optimal choice of exchange rate policies have evolved over time, and the issue is still a matter of significant debate. In the early 1990s, a fixed exchange rate (pegged to the US dollar or German mark) was a popular option for developing countries, especially those transitioning toward market economies. However, the capital account crises and exchange rate collapse that took place in the late 1990s revealed the vulnerability of a fixed exchange rate and resulted in the wide perception that simple pegs might be too risky and that a country should either adopt a hard peg via monetary unions or currency boards, or use a free-floating exchange rate without government intervention (Ghosh and Ostry, 2009 ).

  The collapse of the Argentine peso in 2002 once again shifted mainstream views with regard to the optimal choice of an exchange rate regime by raising new doubts about the viability of hard pegs. Discussions about the merits of an intermediate exchange rate regime followed suit. Yi and Tang (2001) proposed an expanded version of the “impossible trinity” and showed that a country does not have to fully give up any one of the trinity conditions (i.e., a fixed exchange rate, free capital mobility, or monetary independence). The authors argued that it is possible to achieve a combination of the three conditions proportionately. Their proposal suggested that an exchange rate regime does not necessarily have to be a clean float or a hard peg, but in practice, can be an intermediate regime that lies in between the two.

  Husain et al. (2005) found that exchange rate regimes across countries have not exhibited an obvious tendency to evolve toward either a clean float or a hard peg. Instead, intermediate regimes have demonstrated greater sustainability over time. They also found that the merits of a free-floating regime tend to become more prominent as an economy matures. In the early stage of economic development, a fixed exchange rate has the benefit of serving as a nominal anchor that keeps inflation in check. However, as an economy matures and its policy credibility improves, the price-stabilizing function of a fixed exchange rate becomes less important. A free-floating regime, on the other hand, appears more beneficial as mature economies with a free-floating exchange rate tend to achieve superior economic performance. The 2009 International Monetary Fund (IMF) review of exchange rate regimes similarly pointed out that the appropriate choice of exchange rate regime should depend on country-specific contexts: A rigid exchange rate regime helps anchor inflation expectations and sustain economic output, but simultaneously puts greater constraints on macroeconomic policies, increases vulnerability to crises, and impedes macroeconomic adjustments against external shocks (Ostry and Ghosh, 2009

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