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The Forward Exchange Market, Speculation, and Exchange Market Intervention

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  • Eaton, Jonathan
  • Turnovsky, Stephen J

Abstract

This paper develops a stochastic equilibrium model of an open economy incorporating speculation in the forward exchange market. The model is used to examine two issues. The first is the role of speculation in stabilizing the economy against stochastic disturbances. Much risk averse speculation stabilizes domestic income against disturbances in the domestic bond market and forward exchange marketbut exacerbates the effect of foreign disturbances. Speculation may dampen or augment the effect of money market and output supply disturbances depending upon the share of foreign bonds in total wealthand the interest elasticity of bond demand. The second issue that the model addresses is the role of the forward market in stabilization policy. Forward market intervention (or its equivalent in this model,sterilized spot market intervention) does not provide monetary authorities additional leverage in stabilizing income beyond unsterilized spot market intervention. Intervention rules based on reactions to both the forward and the spot exchange rates, however, can outper-form intervention policies responding to the spot rate alone,regardless of the market in which intervention occurs.

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Bibliographic Info

Article provided by MIT Press in its journal Quarterly Journal of Economics.

Volume (Year): 99 (1984)
Issue (Month): 1 (February)
Pages: 45-69

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Handle: RePEc:tpr:qjecon:v:99:y:1984:i:1:p:45-69

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  1. Flood, Robert P, 1979. "Capital Mobility and the Choice of Exchange Rate System," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(2), pages 405-16, June.
  2. Frankel, Jeffrey A., 1979. "The diversifiability of exchange risk," Journal of International Economics, Elsevier, vol. 9(3), pages 379-393, August.
  3. Driskill, Robert & McCafferty, Stephen, 1980. "Exchange-Rate Variability, Real and Monetary Shocks, and the Degree of Capital Mobility under Rational Expectations," The Quarterly Journal of Economics, MIT Press, vol. 95(3), pages 577-86, November.
  4. Boyer, Russell S, 1978. "Optimal Foreign Exchange Market Intervention," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1045-55, December.
  5. S. C. Tsiang, 1959. "The Theory of Forward Exchange and Effects of Government Intervention on the Forward Exchange Market," IMF Staff Papers, Palgrave Macmillan, vol. 7(1), pages 75-106, April.
  6. Adler, Michael & Dumas, Bernard, 1977. "The Microeconomics of the Firm in an Open Economy," American Economic Review, American Economic Association, vol. 67(1), pages 180-89, February.
  7. Fama, Eugene F & Farber, Andre, 1979. "Money, Bonds, and Foreign Exchange," American Economic Review, American Economic Association, vol. 69(4), pages 639-49, September.
  8. Turnovsky, Stephen J, 1976. "The Relative Stability of Alternative Exchange Rate Systems in the Presence of Random Disturbances," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(1), pages 29-50, February.
  9. Don E. Roper & Stephen J. Turnovsky, 1980. "Optimal Exchange Market Intervention in a Simple Stochastic Macro Model," Canadian Journal of Economics, Canadian Economics Association, vol. 13(2), pages 296-309, May.
  10. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
  11. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  12. Taylor, John B, 1977. "Conditions for Unique Solutions in Stochastic Macroeconomic Models with Rational Expectations," Econometrica, Econometric Society, vol. 45(6), pages 1377-85, September.
  13. Buiter, Willem H & Eaton, Jonathan, 1980. "Policy Decentralisation and Exchange Rate Management in Interdependent Economies," The Warwick Economics Research Paper Series (TWERPS) 172, University of Warwick, Department of Economics.
  14. Cox, W. Michael, 1980. "Unanticipated money, output, and prices in the small economy," Journal of Monetary Economics, Elsevier, vol. 6(3), pages 359-384, July.
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Cited by:
  1. Lin, Hwan C., 2008. "Forward-rate target zones and exchange rate dynamics," Journal of International Money and Finance, Elsevier, vol. 27(5), pages 831-846, September.
  2. Hui-Kuan Tseng, 1998. "Exchange Rate Variability and Exchange Market Intervention: Spot vs. Forward," International Economic Journal, Taylor & Francis Journals, vol. 12(2), pages 1-16.
  3. Weymark, Diana N, 1997. "Measuring the degree of exchange market intervention in a small open economy," Journal of International Money and Finance, Elsevier, vol. 16(1), pages 55-79, February.
  4. Suh, Sangwon & Zapatero, Fernando, 2008. "A class of quadratic options for exchange rate stabilization," Journal of Economic Dynamics and Control, Elsevier, vol. 32(11), pages 3478-3501, November.
  5. Weymark, Diana N., 1995. "Estimating exchange market pressure and the degree of exchange market intervention for Canada," Journal of International Economics, Elsevier, vol. 39(3-4), pages 273-295, November.
  6. Patricio Mujica, 1988. "Políticas de Tipo de Cambio: Un Modelo de Tres Países," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 25(75), pages 197-214.
  7. Zapatero, Fernando & Reverter, Luis F., 2003. "Exchange rate intervention with options," Journal of International Money and Finance, Elsevier, vol. 22(2), pages 289-306, April.
  8. Jonathan Eaton, 1983. "Optimal and Time Consistent Exchange Rate Management in an Overlapping Generations Economy," NBER Working Papers 1196, National Bureau of Economic Research, Inc.

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