The Political Economy Of Foreign Exchange Market Intervention
AbstractThe paper tests the effectiveness of marginal reserve requirements employed by the Japanese authorities in the 1970s to influence short-term capital flows, thereby contributing to the ongoing debate on the use of capital controls\market- or price-based ones in particular. While the case for using market-based controls almost entirely relies on the mixed evidence from the experience of Chile with unremunerated reserve requirements in the 1990s, testing for their effectiveness on the volume of inflows is hampered by the endogeneity of such a measure, which is typically imposed or intensified when inflows surge. We address this problem by applying the method of propensity score matching and find that an increase in marginal reserve requirements modestly reduced the volume of short-term capital inflows through non-resident free-yen accounts. The impact was not statistically significant, however, implying that the price elasticity of short-term capital flows was small. We conclude that market-based controls must be nearly prohibitive, perhaps combined with administrative measures, to be effective in a meaningful way.The paper presents a political economy model of official foreign exchange market intervention and tests the model against the recent experience of Japan. In several industrial countries, the government is responsible for intervention decisions while the central bank is given operational independence in its conduct of monetary policy. The paper models the interaction between the two agencies, empirically tests the central bank reaction function, and considers conditions under which intervention might change monetary policy. Daily Japanese intervention data give broad support to the prediction of the model with respect to central bank behavior. Although it is difficult to be definitive about the hidden motive of central bank actions, during the extraordinary period of 2001-04 when Japan remained under deflationary pressure, the central bank, faced with large political costs of sterilization, accommodated a considerable portion of the massive interventions made by the government. Under normal conditions coordination between the two agencies might be desirable, not least to make the signal of any intervention credible, but giving an alternative agency the authority over intervention decisions can be a means of enhancing democratic accountability for an independent central bank while preserving the credibility of monetary policy.
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Bibliographic InfoPaper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 12-04.
Length: 48 pages
Date of creation: Apr 2012
Date of revision:
foreign exchange market intervention; central banking; quantitative easing; Japanese intervention;
Find related papers by JEL classification:
- E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-04-03 (All new papers)
- NEP-MAC-2012-04-03 (Macroeconomics)
- NEP-MON-2012-04-03 (Monetary Economics)
- NEP-POL-2012-04-03 (Positive Political Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Tomas Holub, 2004.
"Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience,"
Research and Policy Notes
2004/01, Czech National Bank, Research Department.
- Adam Gersl & Tomás Holub, 2006. "Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience," Contemporary Economic Policy, Western Economic Association International, vol. 24(4), pages 475-491, October.
- Holub, Tomáš, 2004. "Foreign exchange interventions under inflation targeting: the Czech Experience," Research Notes 17, Deutsche Bank Research.
- Jung, Taehun & Teranishi, Yuki & Watanabe, Tsutomu, 2005. "Optimal Monetary Policy at the Zero-Interest-Rate Bound," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(5), pages 813-35, October.
- Rasmus Fatum & Michael M. Hutchison, 2005. "Foreign Exchange Intervention and Monetary Policy in Japan, 2003-2004," Hi-Stat Discussion Paper Series d05-93, Institute of Economic Research, Hitotsubashi University.
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