Working Paper: CEPR ID: DP3758
Authors: Mark P. Taylor
Abstract: I examine the effectiveness of exchange rate intervention within the context of a Markov-switching model for the real exchange rate. The probability of switching between stable and unstable regimes depends non-linearly upon the amount of intervention, the degree of misalignment and the duration of the regime. Applying this to dollar-mark data for the period 1985-98, I find that intervention increases the probability of stability when the rate is misaligned, and that its influence grows with the degree of misalignment. Intervention within a small neighbourhood of equilibrium will result in a greater probability of instability.
Keywords: Mean reversion; Nonlinearity; Official intervention; Real exchange rate
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 |
|---|---|
| Intervention (D74) | Probability of stability (C62) |
| Probability of stability increases with intervention when the exchange rate is misaligned (F31) | Probability of stability (C62) |
| Intervention within a small neighborhood of equilibrium (C62) | Probability of instability (C62) |
| Intervention may not stabilize the rate but rather perpetuate instability (C62) | Probability of instability (C62) |