Why and how central banks intervene in currency markets

In a system of fixed exchange rates, central banks frequently intervene in the foreign-exchange market to maintain the par value system. Even within the flexible exchange rate system, central banks intervene in the foreign-exchange market to maintain orderly trading conditions. Monetary authorities normally intervene in the foreign-exchange market (1) to smooth exchange rate movements, (2) to establish implicit exchange rate boundaries, and (3) to respond to temporary disturbances. Depending on market conditions, a central bank may:

1 Coordinate its action with other central banks or go it alone.

2 Enter the market aggressively to change attitudes about its views and policies.

3 Call for reassuring action to calm markets.

4 Intervene to reverse, resist, or support a market trend.

5 Operate openly or indirectly through brokers (Cross 2002).

In 1999, the Bank for International Settlements (BIS) sent a questionnaire on the practice of exchange market intervention to 44 central banks, including the European Central Bank. Of 44 institutions, 22 responded to some or all of the questions asked. The Reserve Bank of New Zealand was the only authority to report that it had not intervened in the past 10 years. Table 8.1 shows summary statistics of the intervention survey responses. The survey of central banks' intervention practices reveals that a number of monetary authorities do intervene with some frequency in foreign-exchange (mostly spot) markets. The desire to check short-run trends or correct longer-term misalignments often motivates intervention, whereas the size of the intervention often depends on market reaction to initial trades. Although intervention typically takes place during business hours, most monetary authorities will also intervene outside of these hours if necessary. While there is unanimous agreement that intervention does influence exchange rates, there is much disagreement about the horizon over which the full effect of this influence is felt, with estimates ranging from a few minutes to more than a few days.

Table 8.1 A summary of intervention survey responses

No. of responses Minimum Median Maximum

1 In the last decade, on approximately what 14 0.5 4.5 40.0

percentage of business days has your monetary authority conducted intervention?

No. of responses Never Sometimes Always

No. of responses Never Sometimes Always

2 Foreign-exchange intervention changes the

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  • mantissa
    Why central bank intervene in the foreign exchange market?
    6 months ago

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