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Does Foreign Exchange Intervention Matter? Disentangling the Portfolio and Expectations Effects for the Mark
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Does Foreign Exchange Intervention Matter? Disentangling the Portfolio and Expectations Effects for the Mark

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  • Kathryn M. Dominguez
  • Jeffrey Frankel

Abstract

The time is ripe for a re-examination of the question whether foreign exchange intervention can affect the exchange rate. We attempt to isolate two distinct effects: the portfolio effect, whereby an increase in the supply of marks must reduce the dollar/mark rate (for given expected rates of return) and the additional expectations effect, whereby intervention that is publically known may alter investors expectations of the future exchange rate, which will feed back to the current equilibrium price. We estimate a system consisting of two equations, one describing investors' portfolio behavior and the other their formation of expectations, where the two endogenous variables are the current spot rate and investors' expectation of the future spot rate. We use relatively new data sources: actual daily data on intervention by the Bundesbank, newspaper stories on known intervention, and survey data on investors' expectations. We find evidence of both an expectations effect and a portfolio effect. The statistical significance of the portfolio effect suggests that even sterilized intervention may have had positive effects during the sample period. (It tends to be significant only during the later of our two sample periods, October 1984 to December 1987. That intervention appears less significant statistically during the earlier period, November 1982 to October 1984, could be attributed to the fact that little intervention was undertaken until 1985.) For the magnitude of the effects to be large requires that intervention be publically known. Our (still preliminary) estimates suggest that a typical $100 million of "secret" intervention has an effect of less than 0.1 per cent on the exchange rate, but that the effect of news reports of intervention can be as large as an additional 4 per cent.

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  • Kathryn M. Dominguez & Jeffrey Frankel, 1990. "Does Foreign Exchange Intervention Matter? Disentangling the Portfolio and Expectations Effects for the Mark," NBER Working Papers 3299, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:3299
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    1. Juan J. Echavarría & Luis F. Melo-Velandia & Mauricio Villamizar-Villegas, 2018. "The impact of pre-announced day-to-day interventions on the Colombian exchange rate," Empirical Economics, Springer, vol. 55(3), pages 1319-1336, November.
    2. Michael W. Klein & Eric Rosengren, 1991. "Foreign exchange intervention as a signal of monetary policy," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 39-50.
    3. Lewis, Karen K, 1995. "Are Foreign Exchange Intervention and Monetary Policy Related, and Does It Really Matter?," The Journal of Business, University of Chicago Press, vol. 68(2), pages 185-214, April.
    4. Miksjuk Alexei, 2011. "Study the relation between monetary and exchange rate policy: The case of Belarus," EERC Working Paper Series 11/16e, EERC Research Network, Russia and CIS.
    5. Matías Tapia & Andrea Tokman, 2004. "Effects of Foreign Exchange Intervention under Public Information: The Chilean Case," Economía Journal, The Latin American and Caribbean Economic Association - LACEA, vol. 0(Spring 20), pages 215-256, January.
    6. Dominquez, Kathryn M. & Kenen, Peter B., 1992. "Intramarginal intervention in the EMS and the target-zone model of exchange-rate behavior," European Economic Review, Elsevier, vol. 36(8), pages 1523-1532, December.
    7. Hoshikawa, Takeshi, 2008. "The effect of intervention frequency on the foreign exchange market: The Japanese experience," Journal of International Money and Finance, Elsevier, vol. 27(4), pages 547-559, June.
    8. Kaminsky, Graciela L. & Lewis, Karen K., 1996. "Does foreign exchange intervention signal future monetary policy?," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 285-312, April.
    9. José De Gregorio & Andrea Tokman R, 2005. "Flexible exchange rate regime and forex intervention," BIS Papers chapters, in: Bank for International Settlements (ed.), Foreign exchange market intervention in emerging markets: motives, techniques and implications, volume 24, pages 127-38, Bank for International Settlements.
    10. Michael Bordo & Anna Schwartz, 1991. "What has foreign exchange market intervention since the Plaza Agreement accomplished?," Open Economies Review, Springer, vol. 2(1), pages 39-64, February.
    11. Mundaca, B. Gabriela, 2001. "Central bank interventions and exchange rate band regimes," Journal of International Money and Finance, Elsevier, vol. 20(5), pages 677-700, October.
    12. Svensson, Lars E. O., 1992. "The foreign exchange risk premium in a target zone with devaluation risk," Journal of International Economics, Elsevier, vol. 33(1-2), pages 21-40, August.
    13. José De Gregorio & Andrea Tokman R., 2004. "Flexible Exchange Rate Regime and Forex Interventions: The Chilean Case," Economic Policy Papers Central Bank of Chile 11, Central Bank of Chile.
    14. Michael D. Bordo & Anna J. Schwartz, 1990. "What has Foreign Market Intervention Since the Plaza Agreement Accomplished?," NBER Working Papers 3562, National Bureau of Economic Research, Inc.
    15. David W.R. Gruen, 1991. "The Effect of Steady Inflation on Interest Rates and the Real Exchange Rate in a World with Free Capital Flows," RBA Research Discussion Papers rdp9101, Reserve Bank of Australia.
    16. Olivier Blanchard & Gustavo Adler & Irineu de Carvalho Filho, 2015. "Can Foreign Exchange Intervention Stem Exchange Rate Pressures from Global Capital Flow Shocks?," NBER Working Papers 21427, National Bureau of Economic Research, Inc.
    17. Stéphanie Guichard, 1998. "La politique monétaire et la crise japonaise," Working Papers 1998-06, CEPII research center.
    18. Karunaratne, Neil Dias, 1996. "Exchange rate intervention in Australia (December 1983 to May 1993)," Journal of Policy Modeling, Elsevier, vol. 18(4), pages 397-417, August.
    19. Klein, Michael W., 1993. "The accuracy of reports of foreign exchange intervention," Journal of International Money and Finance, Elsevier, vol. 12(6), pages 644-653, December.
    20. Richard T. Baillie & Owen F. Humpage, 1992. "Post-Louvre intervention: did target zones stabilize the dollar?," Working Papers (Old Series) 9203, Federal Reserve Bank of Cleveland.
    21. Jeffrey A. Frankel, 1990. "The Making of Exchange Rate Policy in the 1980s," NBER Working Papers 3539, National Bureau of Economic Research, Inc.
    22. Ghosh, Atish R., 2002. "Central bank secrecy in the foreign exchange market," European Economic Review, Elsevier, vol. 46(2), pages 253-272, February.
    23. Chang, Mei-Ching & Suardi, Sandy & Chang, Yuanchen, 2017. "Foreign exchange intervention in Asian countries: What determine the odds of success during the credit crisis?," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 370-390.
    24. Reeves, Silke Fabian, 1997. "Exchange rate management when sterilized interventions represent signals of monetary policy," International Review of Economics & Finance, Elsevier, vol. 6(4), pages 339-360.

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