Currency Wars in Action: How Foreign Exchange Interventions Work in an Emerging Economy

This paper investigates the impact of central bank interventions on the level and volatility of exchange rates. We explore the case of Brazil, the 7th largest economy in the world in 2012, which since 1999 has adopted a floating exchange rate. As Central Bank decisions to intervene in the exchange market are not independent of market conditions, we estimated a Central Bank reaction function using a logit model including market fundamentals and macroeconomic surprises as explanatory variables. We employed the nonparametric Propensity Score Matching (PSM) method to find counterfactual pairs of intervention and non-intervention days. This indicated that the effectiveness of foreign exchange interventions depends on the period analyzed. For instance, from 1999 to 2003, with scarce and smaller interventions, the buying operations of U.S. Dollars depreciated the Brazilian Real whereas from 2004 to 2012, a period with larger and frequent interventions, only selling interventions were significant, and tended to increase the currency’s volatility.