Oral interventions in the foreign exchange market: evidence from Australia

In response to the large fluctuations of the Australian dollar in the beginning of the twenty-first century, the Reserve Bank of Australia (RBA) started to express a preference for a weaker domestic currency through public speeches and monetary policy statements in order to achieve balanced economic growth. We construct a novel Exchange Rate Stance Index (ERSI) to measure the magnitude of RBA’s oral interventions in the foreign exchange market. We employ the ERSI in a structural vector autoregressive model to quantify the impact of RBA’s communication on the Australian dollar and overall economic activity. An unanticipated increase in the ERSI leads to a significant weakening of the Australian dollar and considerably stimulates output. The ERSI shocks account for a sizeable fraction of Australia’s macroeconomic fluctuations, comparable to the exchange rate shocks. The impact of ERSI on output is largely transmitted through the exchange rate depreciation.