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

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.