Working Paper: CEPR ID: DP17570
Authors: Andrew Filardo; Gaston Gelos; Thomas McGregor
Abstract: This paper develops a new approach for exploring the effectiveness of foreign currency intervention, focusing on real exchange cycles. Using band spectrum regression methods, it examines the role of macroeconomic fundamentals in determining the equilibrium real exchange rate at short-, medium-, and low frequencies. Next, it assesses the effectiveness of FX intervention depending on the degree of cycle-specific misalignments for 26 advanced- and emerging market economies, covering the period 1990–2018, and using different techniques to mitigate endogeneity concerns. Evidence supports the hypothesis that central banks can lean effectively against short-run cyclical misalignments of the real exchange rate. The effects are present in quarterly data—i.e., at policy-relevant horizons. The effectiveness of intervention rises with the size of the misalignment, and with the duration of one-sided interventions. FX sales appear to be somewhat more effective than FX purchases, and intervention is less effective in more liquid FX markets.
Keywords: Central Banking; Equilibrium Exchange Rates; Foreign Exchange Intervention; Band Spectrum Regression
JEL Codes: E32; E58; F31; F37
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| size of misalignment (C52) | effectiveness of intervention (I24) |
| duration of one-sided interventions (C41) | effectiveness of intervention (I24) |
| FX sales (G15) | effectiveness of intervention (I24) |
| FX purchases (F31) | effectiveness of intervention (I24) |
| one-sided interventions (C90) | effectiveness of intervention (I24) |
| medium- and long-cycle misalignments (E32) | ineffectiveness of interventions (I24) |
| persistent one-sided interventions (C90) | greater effectiveness (C90) |
| Foreign exchange intervention (FXI) surprises (F31) | exchange rate (F31) |
| short-cycle misalignment of 10 percent (E32) | exchange rate change (F31) |