ECON360 Essay
According to Bekaert and Hodrick, foreign exchange intervention is a monetary policy tool utilised to directly influence the exchange rate. Central banks, especially in emerging market economies (EMEs), intervene in foreign exchange markets to change the rate favourably in their direction. According to Dominguez (1986), we live ‘in an era of flexible exchange rates, where currency prices are clearly driven by expectations’. However is this true? Through analysing K. Miyajima’s ‘Foreign exchange intervention and expectation in emerging economies’ it will established whether sterilised intervention has an influence on exchange rate expectations in EMEs.
Miyajima’s aim was to examine the manner in which Central Bank foreign exchange intervention influences exchange rate expectations through a basic model. Originally established by Bachetta and Wincoop (2006), the model was extended to relate these two points along with other key determinants such as interest rate differentials and the effect of credit risk on exchange rates in EMEs. Results found by Miyajima suggested that sterilised intervention, from the Central Bank, does not seem to influence exchange rate expectations in their preferred direction. Thus, dollar purchases/sales made to avoid currency appreciation/depreciation or currency volatility do not influence the exchange rate expectations.
Exchange rate expectations are an integral part of monetary policy in EMEs. Important factors in the fluctuation of these expectations are the fundamentals of macroeconomics; foreseeable growth with low risks makes for attractive foreign investment opportunities, strengthening the exchange rate. Unpredictability in the economy with minimal growth will mean less opportunities and a slowly diminishing exchange rate. In saying this, intervention from the Central Bank can possibly have an effect on these expectations. Since the GFC in 2008, the risk-loving environment had repercussions on the exchange rate, encouraging
Miyajima’s aim was to examine the manner in which Central Bank foreign exchange intervention influences exchange rate expectations through a basic model. Originally established by Bachetta and Wincoop (2006), the model was extended to relate these two points along with other key determinants such as interest rate differentials and the effect of credit risk on exchange rates in EMEs. Results found by Miyajima suggested that sterilised intervention, from the Central Bank, does not seem to influence exchange rate expectations in their preferred direction. Thus, dollar purchases/sales made to avoid currency appreciation/depreciation or currency volatility do not influence the exchange rate expectations.
Exchange rate expectations are an integral part of monetary policy in EMEs. Important factors in the fluctuation of these expectations are the fundamentals of macroeconomics; foreseeable growth with low risks makes for attractive foreign investment opportunities, strengthening the exchange rate. Unpredictability in the economy with minimal growth will mean less opportunities and a slowly diminishing exchange rate. In saying this, intervention from the Central Bank can possibly have an effect on these expectations. Since the GFC in 2008, the risk-loving environment had repercussions on the exchange rate, encouraging