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Reserve Bank Operations in the Foreign Exchange Market: Effectiveness and Profitability

Author

Listed:
  • Robert Andrew

    (Reserve Bank of Australia)

  • John Broadbent

    (Reserve Bank of Australia)

Abstract

Since the float of the Australian dollar in December 1983, the Reserve Bank has intervened in the foreign exchange market in order to exert a stabilising influence. Whether this intervention has been stabilising cannot be directly observed since the behaviour of the exchange rate in its absence cannot be known. However, there are a number of ways of assessing it indirectly. The best known is the Friedman “profits test”. Friedman (1953) argued that a central bank which was stabilising the exchange rate would tend to buy foreign exchange when its price was low, and sell when its price is high, and hence its operations would be profitable. This paper applies the profits test to the Bank’s foreign exchange operations since the exchange rate was floated. The main conclusion is that over this period the Bank’s foreign exchange operations have produced total profits of around $A3.4 billion, suggesting that intervention has tended to be stabilising. Other statistical tests developed by Wonnacott (1982) and Mayer and Taguchi (1983), also presented in this paper, support this conclusion.

Suggested Citation

  • Robert Andrew & John Broadbent, 1994. "Reserve Bank Operations in the Foreign Exchange Market: Effectiveness and Profitability," RBA Research Discussion Papers rdp9406, Reserve Bank of Australia.
  • Handle: RePEc:rba:rbardp:rdp9406
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    File URL: https://www.rba.gov.au/publications/rdp/1994/pdf/rdp9406.pdf
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    References listed on IDEAS

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    1. Owen F. Humpage, 1991. "Central-bank intervention: recent literature, continuing controversy," Economic Review, Federal Reserve Bank of Cleveland, vol. 27(Q II), pages 12-26.
    2. Kenneth A. Froot & Jeffrey A. Frankel, 1989. "Forward Discount Bias: Is it an Exchange Risk Premium?," The Quarterly Journal of Economics, Oxford University Press, vol. 104(1), pages 139-161.
    3. repec:hrv:faseco:33077905 is not listed on IDEAS
    4. Martin Feldstein, 1986. "New Evidence on the Effects of Exchange Rate Intervention," NBER Working Papers 2052, National Bureau of Economic Research, Inc.
    5. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
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    7. 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.
    8. Owen F. Humpage, 1984. "Dollar intervention and the deutschemark-dollar exchange rate: a daily time-series model," Working Papers (Old Series) 8404, Federal Reserve Bank of Cleveland, revised 1984.
    9. De Long, J Bradford & Shleifer, Andrei & Summers, Lawrence H & Waldmann, Robert J, 1991. "The Survival of Noise Traders in Financial Markets," The Journal of Business, University of Chicago Press, vol. 64(1), pages 1-19, January.
    10. Spencer, Peter D, 1985. "Official Intervention in the Foreign Exchange Market," Journal of Political Economy, University of Chicago Press, vol. 93(5), pages 1019-1024, October.
    11. Corrado, Charles J. & Taylor, Dean, 1986. "The cost of a central bank leaning against a random walk," Journal of International Money and Finance, Elsevier, vol. 5(3), pages 303-314, September.
    12. Flood, Robert P & Hodrick, Robert J, 1990. "On Testing for Speculative Bubbles," Journal of Economic Perspectives, American Economic Association, vol. 4(2), pages 85-101, Spring.
    13. Kearney, Colm & MacDonald, Ronald, 1986. "Intervention and sterilisation under floating exchange rates: The UK 1973-1983," European Economic Review, Elsevier, vol. 30(2), pages 345-364, April.
    14. Taylor, Dean, 1982. "Official Intervention in the Foreign Exchange Market, or, Bet against the Central Bank," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 356-368, April.
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    Citations

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    Cited by:

    1. Muhammad Kashif Ali Shah & Zulfiqar Hyder & Muhammad Khalid Pervaiz, 2009. "Central bank intervention and exchange rate volatility in Pakistan: an analysis using GARCH-X model," Applied Financial Economics, Taylor & Francis Journals, vol. 19(18), pages 1497-1508.
    2. Jonathan Kearns & Roberto Rigobon, 2002. "Identifying the Efficacy of Central Bank Interventions: The Australian Case," NBER Working Papers 9062, National Bureau of Economic Research, Inc.
    3. Neely, Christopher J., 2008. "Central bank authorities' beliefs about foreign exchange intervention," Journal of International Money and Finance, Elsevier, vol. 27(1), pages 1-25, February.
    4. Christopher J. Neely, 2005. "The case for foreign exchange intervention: the government as an active reserve manager," Working Papers 2004-031, Federal Reserve Bank of St. Louis.
    5. Stephen Grenville, 2010. "Central Banks and Capital Flows," Chapters, in: Masahiro Kawai & Mario B. Lamberte (ed.),Managing Capital Flows, chapter 3, Edward Elgar Publishing.
    6. Hali Edison & Paul Cashin & Hong Liang, 2006. "Foreign exchange intervention and the Australian dollar: has it mattered?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(2), pages 155-171.
    7. Kim, Suk-Joong & Kortian, Tro & Sheen, Jeffrey, 2000. "Central bank intervention and exchange rate volatility -- Australian evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 10(3-4), pages 381-405, December.
    8. Hali Edison & Paul Cashin & Hong Liang, 2006. "Foreign exchange intervention and the Australian dollar: has it mattered?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 11(2), pages 155-171.
    9. Kisukyabo Simwaka & Leslie Kwacha Mkandawire, 2004. "The Efficacy of Foreign Exchange Market Intervention in Malawi," Macroeconomics 0407022, University Library of Munich, Germany.
    10. Simatele, Munacinga & Sjö, Bo & Sweeny, Richard, 2016. "Do Developing Countries Lose Money on Central Bank Intervention? The Case of Zambia in Copper-Market Boom and Bust," LiU Working Papers in Economics 2, Linköping University, Division of Economics, Department of Management and Engineering.
    11. Shakila Aruman, 2003. "The Effectiveness of Foreign Exchange Intervention in Australia: A Factor Model Approach with GARCH Specifications," School of Economics and Finance Discussion Papers and Working Papers Series 135, School of Economics and Finance, Queensland University of Technology.

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