Unsterilized Intervention

8 Key excerpts on "Unsterilized Intervention"

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  eBook - ePub

  International Money and Credit : The Policy Roles

  • INTERNATIONAL MONETARY FUND(Author)
  • 1984(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  b declines, thereby producing a negative risk premium. The question of the effectiveness of the interventions then simply boils down to the question of the degree of substitutability between A- and B-bonds. With high substitutability, the size of the sales of B-bonds and purchases of A-bonds will have to be large. In the limit of perfect substitution, no finite amounts will suffice to change the risk premium. In that case, sterilized intervention by the two countries becomes completely ineffective.

  Does it matter which central bank intervenes, when the intervention is sterilized? What is obtained here is an answer similar to the one obtained for the nonsterilized intervention. If the pure intervention is symmetrical (both countries’ money stocks are unaffected), it does not matter whether country A or B intervenes. In both cases, the money stock is pegged, and the risk premium (—II) will be the same.13 Thus, the conclusion is the same as when the two authorities abstain from sterilization.

  This conclusion will be different if we assume asymmetry in sterilization behavior. If a country does not sterilize the domestic monetary effects of the other country’s intervention, the question of who does the intervention becomes important again. The analysis here is the same as in the previous section. This leads to a general proposition: It does not matter which central bank intervenes in the exchange market if the institutional arrangements are symmetric—that is, if both central banks abstain from sterilization or if both central banks fully sterilize. However, if the arrangements are asymmetric, it makes a difference who intervenes in the foreign exchange market.

  This section can be summarized as follows. Intervention policies in the foreign exchange market by one country have quite different effects, depending on the way the other country whose currency is bought or sold conducts its monetary policies. This is true when a country engages in sterilized or nonsterilized intervention. It has also been emphasized that the degree of substitution between domestic and foreign bonds is important for the effectiveness of (pure) intervention policies. The discussion in this section, however, also stresses that for a given degree of substitution, a particular intervention policy followed by one country will be more or less effective, depending on such institutional arrangements as the form in which international reserves are held or the extent to which countries sterilize the interventions of other countries. It is clear that cooperative arrangements can be found that enhance the effectiveness of foreign exchange market interventions. In general, nonsterilized interventions will be more effective if they are symmetrical. Sterilized interventions, however, are more effective if they are asymmetrical.

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  Exchange Rates, Capital Flows and Policy

  • Rebecca Driver, Peter J N Sinclair, Christoph Thoenissen(Authors)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  The extent to which a central bank sterilizes the effect of foreign exchange intervention on the monetary base can vary with many factors. Among those are capital mobility, different types and nature of disturbances underlying movements in exchange rate, business cycle, fiscal flexibility, and private agents’ asset demand behavior (Calvo 1991; Frankel 1994; Kletzer and Spiegel 1996; Glick and Hutchison 2000). There is little scope for sterilization as financial markets are increasingly globalized and in turn capital mobility or substitutability between foreign and domestic assets becomes greater and greater. Although sterilized intervention remains feasible to some degree, its effectiveness depends on the way it is implemented. Furthermore, monetary policy will be independent of exchange rate policies only if foreign exchange interventions are completely sterilized in the long run. The fact that the degree of short-term sterilization is high has no significant implications for monetary control, while it can reduce the initial impact of intervention on the monetary base and distribute its effect more smoothly over time.

  This chapter presents an empirical analysis of the relationship between foreign exchange market intervention and monetary controls in Korea over the managed floating exchange rate period 1981–2001. The study investigates how the Korean monetary authorities intervened in the foreign exchange market in response to exchange rate movements, and the extent to which such exchange rate policies might have influenced the monetary base and money supply or interest rates. The rest of the chapter is organized as follows. Section 2 sets out balance of payments and central bank balance sheet identities as well as monetary policy reaction functions and reviews the theoretical predictions of the possible linkages between foreign exchange interventions, sterilization, and monetary controls. Section 3.1 reviews some stylized facts about movements in the exchange rate of the Korean won against the US dollar, official foreign reserves, and related variables during the period 1981–2001. Section 3.2 and 3.3 present econometric analyses of the behavior of foreign exchange intervention and sterilization respectively. Section 4

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  The Economics of Exchange Rates

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

    (Publisher)

  31 , 32 A move in this direction is due to Bhattacharya and Weller (1997), who build an asym-metric information model of sterilised intervention where the equilibrium is characterised by a situation in which the central bank has inside information about its exchange rate target whereas risk-averse speculators have inside information about future spot rates. In that framework, circumstances may arise in which ‘perverse’ responses to intervention may occur, and ultimately the model provides a rationale for secrecy with regard not only to the scale, but also to the target, of official intervention. 33 Game-theoretic approaches have also been undertaken by researchers (e.g. Alogoskoufis, 1994). Typically, these models analyse the interaction between the central bank and pri-vate rational speculators in the foreign exchange market: in the event of a shock, observed by both parties, the central bank wishes to counterbalance the effect of the shock and 29 Assuming, for example, that the exchange rate follows a random walk process s t = α 0 + s t − 1 + t , where α 0 denotes the constant rate of exchange rate depreciation and t is a white-noise error, and allowing for official sterilised intervention in the exchange rate equation yields s t = α 0 + α 1 I NT t + t , with α 1 > 0. 30 These costs may be, for example, bureaucratic costs incurred during the decision-making process for designing the optimal intervention strategy or financial losses caused by a purchase (sale) of foreign currency which is not followed by future appreciation (depreciation) of the domestic currency. While in the absence of intervention costs the central bank counteracts to every single idiosyncratic shock, in the presence of positive costs of intervention, the decision to respond to a shock with sterilised intervention is based on a cost-benefit analysis of foreign exchange intervention (see Almekinders, 1995).

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  The Development of International Monetary Policy

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

    (Publisher)

  Table 7.2 . The sample sizes have variations because of the varying number of willing respondents. The number of respondents is much smaller for Asia, relative to Latin America. Based on daily foreign exchange market turnover, two central banks in Emerging Europe intervened more aggressively. However, from 2007 to 2012, the size of interventions seems to be generally irregular.

  The size of intervention relative to FX market turnover is symptomatic of a central banks’ market power to affect the current exchange rate, and its share in FX reserves as a measure of their potential strength to influence the future exchange rate. As a group, the Emerging Economies seem to have some amount of market power though their collective strength declined after 2007. The Banks of Korea, Poland, and India intervened to stabilise their currencies after the 2007 crisis (Mohanty and Berger 2013: 61–2).

  Beyond the stabilisation of fixed exchange rates, sterilised interventions (those dealing with disruptive capital flows) are designed to attain external stability rather than domestic or internal stability. Central banks may purchase and sell foreign currencies in a manner that is not intended to alter the domestic monetary conditions, base money supply (money as a medium of exchange and store of value), and implicitly, the short-term interest rate.

  The manipulation of the value of a currency falls within a broader spectrum of politics, economics, and law. Implicitly, by the connotation of verbiage, the practice of manipulation is designed to gain undue competitive advantage, which may or may not be disruptive. Since the effects of manipulation have implications for fair international trade, one might reasonably presume that the World Trade Organization (WTO) should have authoritative rights to adjudicate the effects of unwarranted currency valuation. Apparently, exchange rates and trade issues are curiously considered to be separate issues for specialised administration. The IMF is responsible for investigating and making a determination that the value of a currency has been manipulated while the WTO is limited to trade issues. This curious anomaly has made it impractical to resolve exchange rate disputes satisfactorily.

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  Contemporary Issues in Macroeconomics

  Lessons from The Crisis and Beyond

  • Joseph E. Stiglitz, Joseph E. Stiglitz, Kenneth A. Loparo, Martin Guzman, Joseph E. Stiglitz, Martin Guzman(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  If policymakers do care about the exchange rate, can they do better than the strict IT-cum-floating-exchange-rate regime implies? The answer is yes. Indeed, in this very simple example, there is a clear policy assignment rule: the interest rate should be used to meet the inflation target, while sterilized intervention should be geared to the exchange rate objective. Thus, the policy interest rate would be lowered in the face of negative demand shocks but would not react to capital flow shocks, while intervention would be used to resist appreciation pressures from inflows and depreciation from negative demand shocks.

  Despite its simplicity, this benchmark model embodies a basic truth: if policymakers have multiple objectives (which they surely do), and if the central bank has multiple instruments (which it probably has), then in general it makes sense to use the full set of available instruments. While it is difficult to argue against this point in the abstract, in our particular context, three objections can be raised. First, that modern EME central banks (like their advanced-economy counterparts) are largely indifferent to the level of the exchange rate provided they are meeting their inflation objective. Second, that central banks do not really have two instruments because sterilized intervention is ineffective. Third, that the flexibility afforded by an active exchange rate policy is not costless because it potentially sends confusing signals about the primacy of the inflation target, undermining its credibility.

  The first objection – that central banks are largely indifferent to the level of the exchange rate – is addressed in Ostry et al. (2012a), which presents empirical evidence on the degree to which policy settings, including FX intervention, react to the exchange rate. The second objection is taken up in the next section of this chapter. On the third, that is on whether having a second policy objective undermines the credibility of the inflation target, I would argue no

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  Dollar Overvaluation and the World Economy

  • C. Fred Bergsten, John Williamson, C. Fred Bergsten, John Williamson(Authors)
  • 2003(Publication Date)
  • Peterson Institute for International Economics

    (Publisher)

  The Effectiveness of Intervention The literature on the effectiveness of exchange market intervention on spot exchange rates has blossomed since the early 1980s, aided in large part by the studies that were produced at the Federal Reserve and elsewhere as background for the Jurgensen Report. 2 Neither the research that was done as background for the Jurgensen Report nor any of the subsequent research justifies the opinion expressed by Kathryn Dominguez in her paper for this conference that the conventional view as of the early 1990s was that ‘‘intervention could only be effective if combined with contempo-raneous changes in money supply (or, in other words, only if interventions were unsterilized).’’ Sterilized intervention never has been dead as a policy instrument even for the major economies with large open capital markets; the issue always has been how effective it is and to what extent it can be relied on as an instrument of policy. Research on the effectiveness of intervention has been aided by the gradual relaxation of prohibitions on access to intervention data, but the availability of those data has proven to be less helpful than many had hoped in resolving the basic issues surrounding the effectiveness of inter-vention. One reason is the lack of a robust model explaining exchange rate determination. Dominguez, working alone (1987) and also collaborating with Jeffrey A. Frankel (1993), has been one of the major contributors to this literature. In the paper she presented at this conference, Dominguez continues in that tradition of careful and rich analysis. In part she uses statistical techniques to examine intervention episodes that are as short as a single day and as long as several years. 3 She examines intervention by G-3 (Japanese, German/European, and US) monetary authorities. She presents the results of a range of tests from four-hour effects to 48-hour effects and beyond.

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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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  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)

  Japan participated, buying nearly $1.7 billion, but Germany remained out of the market. At the 15 November 1994 FOMC meeting, Federal Reserve Bank of Richmond President Broaddus argued against intervention because it must interfere with the Federal Reserve’s monetary-policy independence: As you said, Mr. Chairman, it is now widely agreed that sterilized intervention doesn’t have any sustained impact on exchange rates unless it sends a signal that we are going to follow it up with a monetary policy action. This implies, for me at least, and this is really the heart of the matter, that it is not really possible for the Fed to maintain a truly independent monetary policy for an extended period of time while following the Treasury’s lead on foreign exchange policy. Now, of course, in reality the way I see this is that we have maintained our independence by not making a commitment to follow interventions with monetary policy actions. But that’s not a perfect situation either. (FOMC Transcripts, 15 November 1994, 49) In 1995, the Federal Reserve Bank of Richmond articulated the case against intervention (Broaddus and Goodfriend 1996). 46 Although most of the core arguments were well known to FOMC participants, Richmond’s perspective seemed fresh because the authors developed the exposition more completely and clearly than heretofore had been the case. They focused on the connection between intervention and monetary-policy credibility. Sterilized intervention and the institutions associated with intervention damaged the Federal Reserve’s credibility with respect to price stability, they claimed, because Congress had never statutorily mandated price stability as the Fed’s sole—or even chief—policy goal. The central bank’s credibility with respect to price stability was purely reputation-based. Such credibility is hard to acquire and is inherently fragile

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