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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. Alberto Giovannini & Philippe Jorion, 1988. "The Time-Variation of Risk and Return in the Foreign Exchange and Stock Markets," NBER Working Papers 2573, National Bureau of Economic Research, Inc.
  2. Dominguez, Kathryn M., 1986. "Are foreign exchange forecasts rational? : New evidence from survey data," Economics Letters, Elsevier, Elsevier, vol. 21(3), pages 277-281.
  3. Pentti J. K. Kouri & Jorge Braga De Macedo, 1978. "Exchange Rates and the International Adjustments Process," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 9(1), pages 111-158.
  4. Rogoff, Kenneth, 1984. "On the effects of sterilized intervention : An analysis of weekly data," Journal of Monetary Economics, Elsevier, Elsevier, vol. 14(2), pages 133-150, September.
  5. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1977. "Exchange rates in the short run: The dollar-dentschemark rate," European Economic Review, Elsevier, Elsevier, vol. 10(3), pages 303-324.
  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. Loopesko, Bonnie E., 1984. "Relationships among exchange rates, intervention, and interest rates: An empirical investigation," Journal of International Money and Finance, Elsevier, Elsevier, vol. 3(3), pages 257-277, December.
  8. Paul R. Krugman, 1985. "Is the strong dollar sustainable?," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, Federal Reserve Bank of Kansas City, pages 103-155.
  9. 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, Elsevier, vol. 23(3), pages 359-376, May.
  10. Domowitz, Ian & Hakkio, Craig S., 1985. "Conditional variance and the risk premium in the foreign exchange market," Journal of International Economics, Elsevier, Elsevier, vol. 19(1-2), pages 47-66, August.
  11. Pentti J.K. Kouri & Jorge B. de Macedo, 1978. "Exchange Rates and the International Adjustment Process," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 488, Cowles Foundation for Research in Economics, Yale University.
  12. Branson, William H. & Henderson, Dale W., 1985. "The specification and influence of asset markets," Handbook of International Economics, Elsevier, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 15, pages 749-805 Elsevier.
  13. Froot, Kenneth A & Frankel, Jeffrey A, 1989. "Forward Discount Bias: Is It an Exchange Risk Premium?," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 104(1), pages 139-61, February.
  14. Michael P. Dooley & Peter Isard, 1979. "The portfolio-balance model of exchange rates," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 141, Board of Governors of the Federal Reserve System (U.S.).
  15. Froot, Kenneth A. & Ito, Takatoshi, 1989. "On the consistency of short-run and long-run exchange rate expectations," Journal of International Money and Finance, Elsevier, Elsevier, vol. 8(4), pages 487-510, December.
  16. Kathryn M. Dominguez, 1989. "Market Responses To Coordinated Central Bank Intervention," NBER Working Papers 3192, National Bureau of Economic Research, Inc.
  17. Dooley, Michael & Isard, Peter, 1982. "A portfolio-balance rational-expectations model of the dollar-mark exchange rate," Journal of International Economics, Elsevier, Elsevier, vol. 12(3-4), pages 257-276, May.
  18. 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.
  19. Golub, Stephen S., 1989. "Foreign-currency government debt, asset markets, and balance of payments," Journal of International Money and Finance, Elsevier, Elsevier, vol. 8(2), pages 285-294, June.
  20. Goodhart, Charles, 1988. "The Foreign Exchange Market: A Random Walk with a Dragging Anchor," Economica, London School of Economics and Political Science, London School of Economics and Political Science, vol. 55(220), pages 437-60, November.
  21. Charles Engel & Anthony P. Rodrigues, 1987. "Tests of International CAPM with Time-Varying Covariances," NBER Working Papers 2303, National Bureau of Economic Research, Inc.
  22. Maurice Obstfeld, 1988. "The Effectiveness of Foreign-Exchange Intervention: Recent Experience," NBER Working Papers 2796, National Bureau of Economic Research, Inc.
  23. 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.
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Citations

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Cited by:
  1. Hoshikawa, Takeshi, 2008. "The effect of intervention frequency on the foreign exchange market: The Japanese experience," Journal of International Money and Finance, Elsevier, Elsevier, vol. 27(4), pages 547-559, June.
  2. Jeffrey Frankel., 1991. "The Making of Exchange Rate Policy in the 1980s," Economics Working Papers, University of California at Berkeley 91-157, University of California at Berkeley.
  3. Mundaca, B. Gabriela, 2001. "Central bank interventions and exchange rate band regimes," Journal of International Money and Finance, Elsevier, Elsevier, vol. 20(5), pages 677-700, October.
  4. 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, Elsevier, vol. 36(8), pages 1523-1532, December.
  5. Graciela L. Kaminsky & Karen K. Lewis, 1996. "Does foreign exchange intervention signal future monetary policy?," Working Papers 96-7, Federal Reserve Bank of Philadelphia.
  6. 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.
  7. 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, Federal Reserve Bank of Boston, issue May, pages 39-50.
  8. Michael W. Klein, 1992. "The Accuracy of Reports of Foreign Exchange Intervention," NBER Working Papers 4165, National Bureau of Economic Research, Inc.
  9. 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, Reserve Bank of Australia rdp9101, Reserve Bank of Australia.
  10. Reeves, Silke Fabian, 1997. "Exchange rate management when sterilized interventions represent signals of monetary policy," International Review of Economics & Finance, Elsevier, Elsevier, vol. 6(4), pages 339-360.
  11. 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.
  12. St├ęphanie Guichard, 1998. "La politique mon├ętaire et la crise japonaise," Working Papers 1998-06, CEPII research center.

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