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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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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3299.

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Date of creation: Mar 1990
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Publication status: Published as "Does Foreign Exchange Intervention Matter? The Portfolio Effect," American Economic Review, vol. 83, no. 5, p. 1356-1369 (December 1993)
Handle: RePEc:nbr:nberwo:3299

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  1. Backus, David K. & Kehoe, Patrick J., 1989. "On the denomination of government debt : A critique of the portfolio balance approach," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 359-376, May.
  2. Dooley, Michael & Isard, Peter, 1982. "A portfolio-balance rational-expectations model of the dollar-mark exchange rate," Journal of International Economics, Elsevier, vol. 12(3-4), pages 257-276, May.
  3. Michael P. Dooley & Peter Isard, 1979. "The portfolio-balance model of exchange rates," International Finance Discussion Papers 141, Board of Governors of the Federal Reserve System (U.S.).
  4. Dominguez, Kathryn Mary, 1990. "Market responses to coordinated central bank intervention," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 32(1), pages 121-163, January.
  5. Dominguez, Kathryn M., 1986. "Are foreign exchange forecasts rational? : New evidence from survey data," Economics Letters, Elsevier, vol. 21(3), pages 277-281.
  6. Jeffrey A. Frankel, 1985. "The Dazzling Dollar," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 16(1), pages 199-217.
  7. Kenneth A. Froot & Takatoshi Ito, 1988. "On the Consistency of Short-run and Long-run Exchange Rate Expectations," NBER Working Papers 2577, National Bureau of Economic Research, Inc.
  8. Rogoff, Kenneth, 1984. "On the effects of sterilized intervention : An analysis of weekly data," Journal of Monetary Economics, Elsevier, vol. 14(2), pages 133-150, September.
  9. Maurice Obstfeld, 1988. "The Effectiveness of Foreign-Exchange Intervention: Recent Experience," NBER Working Papers 2796, National Bureau of Economic Research, Inc.
  10. Giovannini, Alberto & Jorion, Philippe, 1989. " The Time Variation of Risk and Return in the Foreign Exchange and Stock Markets," Journal of Finance, American Finance Association, vol. 44(2), pages 307-25, June.
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  12. Jeffrey A. Frankel & Kenneth A. Froot, 1986. "The Dollar as an Irrational Speculative Bubble: A Tale of Fundamentalisists," NBER Working Papers 1854, National Bureau of Economic Research, Inc.
  13. Engel, Charles & Rodrigues, Anthony P, 1989. "Tests of International CAPM with Time-Varying Covariances," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 4(2), pages 119-38, April-Jun.
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  15. Goodhart, Charles, 1988. "The Foreign Exchange Market: A Random Walk with a Dragging Anchor," Economica, London School of Economics and Political Science, vol. 55(220), pages 437-60, November.
  16. Branson, William H. & Henderson, Dale W., 1985. "The specification and influence of asset markets," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 15, pages 749-805 Elsevier.
  17. Pentti J.K. Kouri & Jorge B. de Macedo, 1978. "Exchange Rates and the International Adjustment Process," Cowles Foundation Discussion Papers 488, Cowles Foundation for Research in Economics, Yale University.
  18. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1977. "Exchange rates in the short run: The dollar-dentschemark rate," European Economic Review, Elsevier, vol. 10(3), pages 303-324.
  19. Kenneth A. Froot and Jeffrey A. Frankel., 1988. "Forward Discount Bias: Is It an Exchange Risk Premium?," Economics Working Papers 8874, University of California at Berkeley.
  20. Loopesko, Bonnie E., 1984. "Relationships among exchange rates, intervention, and interest rates: An empirical investigation," Journal of International Money and Finance, Elsevier, vol. 3(3), pages 257-277, December.
  21. Paul R. Krugman, 1981. "Consumption Preferences, Asset Demands, and Distribution Effects in International Financial Markets," NBER Working Papers 0651, National Bureau of Economic Research, Inc.
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  23. Golub, Stephen S., 1989. "Foreign-currency government debt, asset markets, and balance of payments," Journal of International Money and Finance, Elsevier, vol. 8(2), pages 285-294, June.
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Citations

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Cited by:
  1. Kaminsky, G.L. & Lewis, K.K., 1992. "Does Foreign Exchange Intervention Signal Future Monetary Policy?," Weiss Center Working Papers 93-3, Wharton School - Weiss Center for International Financial Research.
  2. Michael W. Klein & Eric S. 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. 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.
  4. St├ęphanie Guichard, 1998. "La politique mon├ętaire et la crise japonaise," Working Papers 1998-06, CEPII research center.
  5. Karen K. Lewis, 1993. "Are Forign Exchange Intervention and Monetary Policy Related and Does it Really Matter?," NBER Working Papers 4377, National Bureau of Economic Research, Inc.
  6. Kathryn M. Dominguez & Peter B. Kenen, 1991. "Intramarginal Intervention in the EMS and the Target-Zone Model of Exchange-Rate Behavior," NBER Working Papers 3670, National Bureau of Economic Research, Inc.
  7. Jeffrey A. Frankel, 1990. "The Making of Exchange Rate Policy in the 1980s," NBER Working Papers 3539, National Bureau of Economic Research, Inc.
  8. 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.
  9. 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.
  10. 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.
  11. 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.
  12. 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.

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