Foreign Exchange Market Intervention

12 Key excerpts on "Foreign Exchange Market Intervention"

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  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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  Financial Reforms in Modern China

  A Frontbencher's Perspective

  • Sun Guofeng(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Foreign Exchange Market ● 139 Comparative Analysis of Foreign Exchange Intervention by Foreign Monetary Authorities 2 The Summit of the Industrialized Countries held in June 1982 at Versailles resolved to establish a “Working Group on Exchange Market Intervention” with economists to specifically study the issues on foreign exchange mar- ket intervention. In 1983, the Working Group released a “Report of the Working Group” (also known as the “Jurgensen Report”), in which for- eign exchange intervention is narrowly defined as “any trading of foreign exchange against domestic currency which monetary authorities conduct in the exchange market”; it may take the form of foreign exchange reserves, swaps between central banks, or official loans, etc. I. Decision-Making Institutions and Operational Institutions of Foreign Exchange Intervention Exchange rate policy is an integral part of monetary policy, carried out by the central bank. Due to the Bretton Woods System and other historical reasons, the treasury departments of some countries are also involved in decision-making related to foreign exchange intervention. In the United States, the Federal Reserve Board and the Treasury Department make joint-decision on foreign exchange intervention. Nominally, the Treasury Department is responsible for international policy and negotiates with the central bank upon decisions on Foreign Exchange Market Intervention, but actually the Federal Reserve has considerable decision-making power. In the times of Paul Volcker and Alan Greenspan, the Federal Reserve’s Chairman and the Secretary of the Treasury usually had different opinions on US dollar exchange rate and would only make an intervention after they have reached some kind of consensus. In England, the Bank of England and the Treasury jointly make deci- sions about foreign exchange intervention.

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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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  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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  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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  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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  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)

  The objective was to provide background information to help the committee in their deliberations about intervention. The eleven Task Force papers, which the board and the Federal Reserve Bank of New York completed for the 27 March 1990 FOMC meeting, covered all aspects of the Federal Reserve’s involvement: its legal authority for foreign currency operations; the Federal Reserve’s objectives, tactics, and operations; cooperation between the US Treasury and the Federal Reserve System in this area; the various arrangements for financing intervention operations; its effectiveness and profitability, and intervention operations in other key developed countries. Although the papers did not espouse an overt position on intervention, Cross and Truman (1990), who summarized the work, took a firm position in favor of continued operations. Cross and Truman saw foreign-exchange-market intervention as providing the Federal Reserve with a policy tool that could influence exchange rates independent of monetary policy, despite providing no evidence to support such a claim. They did not describe intervention as a response to a market failure, but claimed instead that policymakers “no longer can expect that exchange rates will take care of themselves. .. in ways that US policy would like or find acceptable with respect to conditions in the domestic economy” (12). 41 They asserted that monetary policy could not ignore exchange rates and that the “Federal Reserve’s active participation has been constructive both in terms of US exchange rate policy and US macroeconomic policy” (13). Moreover, Cross and Truman did not find evidence that inappropriate exchange-rate considerations or international (G7) understandings on exchange rates had subverted Federal Reserve monetary policy (13), and they noted that the lack of empirical support for intervention did not mean that the operations were ineffective (14)

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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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  Renminbi from Marketization to Internationalization

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

    (Publisher)

  Source: Das et al. (2020). Note: Das et al. (2020) estimate external investment returns using the IMF’s cross-border investment stock and flow data, see Gourinchas and Rey (2007) for more details regarding the methodology.

  FXI can also inhibit the development of foreign exchange derivatives markets. FXI, in practice, may not always involve direct purchases and sales in the spot market, but may alternatively take place in the derivatives markets with policy measures such as requiring payment of foreign exchange risk reserves. Intervention in the derivatives market serves the purpose of countering depreciation or appreciation pressure without directly tapping foreign reserve assets. An important side effect of FXI in the derivatives market is that the distorted price or additional cost of hedging as a result of intervention policies may drive away investors who have real hedging needs, thereby creating market barriers to risk-management tools. Such intervention policies contradict a sustainable market-based approach to risk management and can result in underdevelopment of the derivatives market. Hofman et al. (2020) found that the case for FXI appears strongest in countries with severe currency mismatch and underdeveloped markets. Their findings suggest that sustained use of FXI may entrench adverse initial conditions such as an underdeveloped market, giving rise to a negative policy-induced feedback loop.

  Another costly consequence of FXI is that it can put the central bank in a dilemma by creating conflicting goals between inflation and exchange rate targets. An important mandate of the central bank is to maintain price stability, but inflation targets may be compromised if the central bank simultaneously attempts to achieve an exchange rate target. Granted, there are circumstances under which inflation targets are compatible with exchange rate targets. For example, when a country tries to combat deflationary pressure, FXI that sells domestic currencies in exchange for foreign currencies helps ramp up inflation. Similarly, when a country experiences inflationary pressure, FXI that sells foreign currencies in exchange for domestic currencies helps rein in inflation. However, under many circumstances in practice, the objectives of FXI often conflict with inflation targets. For instance, countries often resort to FXI under a crisis scenario with a rising current account deficit, capital outflows, exchange rate depreciation, and deflation. FXI that involves reserve sales may reinforce deflationary pressure if no immediate and complete sterilization policies are in place. On the other hand, reserve accumulation typically takes place under a rising current account surplus, capital inflows, appreciation pressure, and inflation. Hence, FXI that is not fully sterilized could further fuel inflation.

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  Exchange Rate Theory and Practice

  • John F. Bilson, Richard C. Marston, John F. Bilson, Richard C. Marston(Authors)
  • 2007(Publication Date)
  • University of Chicago Press

    (Publisher)

  Stockman (1979) has explicitly modeled the possible effects of intervention on expecta- tions. 391 Exchange Market Intervention Operations Bretton Woods system. In any case, the argument is not just a trivial special case of the proposition that any policy action might alter expectations. In- tervention policy and monetary policy are often, if not always, in the hands of the same authorities. Furthermore, losses on foreign exchange positions can lead to significant political problems for the authorities. Thus, if the authorities undertake an intervention policy which would generate foreign exchange losses if their pronouncements about future monetary policy were not put into effect, there might be more reason for private agents to take these pronouncements seriously. However, private agents do have a number of past episodes on which to base an evaluation of such policy packages, some of which would tend to make them wary. The argument that intervention policy may not alter the exchange rate when securities are imperfect substitutes represents a more fundamental challenge to previous theory. It has long been recognized that the answers to certain basic questions, such as whether open market operations are neu- tral and whether replacing tax financing of government expenditure with bond financing is neutral, depend on whether government bonds are net wealth, that is, on whether private agents regard the claims and obligations of the government as their own. For the most part, closed economy models have been used to chart this territory. Recent contributions make clear that whether sterilized intervention can affect the exchange rate when securities are imperfect substitutes also depends on whether private agents “see through” government transactions.

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