Working Paper: CEPR ID: DP2690
Authors: Lucio Sarno; Mark P. Taylor
Abstract: In this Paper we assess the progress made by the profession in understanding whether and how exchange rate intervention works. To this end, we review the theory and evidence on official intervention, concentrating primarily on work published within the last decade or so. Our reading of the recent literature leads us to conclude that, in contrast with the profession's consensus view of the 1980s, official intervention can be effective, especially through its role as a signal of policy intentions, and especially when it is publicly announced and concerted. We also note, however, an apparent empirical puzzle concerning the secrecy of much intervention and suggest an additional way in which intervention may be effective but which has so far received little attention in the literature, namely through its role in remedying a coordination failure in the foreign exchange market.
Keywords: Nonlinear dynamics; Purchasing power parity; Real exchange rate; Test power; Unit root test
JEL Codes: C10; F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Official intervention in the foreign exchange market (F31) | Effectiveness of intervention (I24) |
| Publicly announced and concerted actions (D70) | Effectiveness of intervention (I24) |
| Signaling channel (L96) | Alters market expectations regarding policy intentions (E43) |
| Intervention (D74) | Addresses coordination failure among traders (D52) |
| Addresses coordination failure among traders (D52) | Facilitates simultaneous actions (C30) |
| Facilitates simultaneous actions (C30) | Corrects misalignments in exchange rates (F31) |