Does Foreign Exchange Intervention Matter? Disentangling the Portfolio and Expectations Effects
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 publicly 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 new data sources: actual daily data on intervention by the Fed, the Bundesbank, and the Swiss National Bank, newspaper stories on exchange rate policy announcements and 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. For the magnitude of the effects to be large requires that intervention be publicly known.
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