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In the United States, the Treasury Department and Federal Reserve Board have
join authority for foreign exchange intervention; however, the Treasury
Department has priority with regard to the decision. Once the decision to
intervene is made, the policy is carried out by the Federal Reserve Bank of New
York.
There are cases where two or more monetary authorities implement intervention
jointly by using their own funds at the same time or in succession. This is called
"coordinated intervention."
Since the demise of the Bretton Woods Exchange Rate System in the early
1970s, Japan has been one of the largest interveners in foreign exchange
markets. Between April 1991 and December 2000, for example, the Bank of
Japan bought U.S. dollars on 168 occasions for a cumulative amount of $304
billion and sold U.S. dollars on 33 occasions for a cumulative amount of $38
billion.
Japanese intervene overshadows all other countries' official intervention in the
foreign exchange market; exceeding U.S. intervention over the April 1991 to
December 2000 period by a factor of more than 30. It should be pointed out,
however, that the magnitudes of any central bank intervention, including those by
the Bank of Japan, are very small compared to overall market transactions in the
foreign exchange market.
As seen in the above chart, during this period, intervention can be divided into
three sub-periods: (1) 1991-1995, (2) 1997-98, (3) 1999-2000.
Since few studies have found evidence supporting a link between intervention
and exchange rates, many professional economists tend to be skeptical about
whether official intervention could (or should) play an important role as an
effective policy instrument to influence exchange rates. The most positive study
(Hutchison, 2003) suggested some success as measured in either slowing or
reversing the direction of exchange rate change out to periods of up to two
weeks. After that period of time, market fundamentals become dominate once
again.
The issue for central banks is really two fold. First, their intervention activities, by
their very nature, can only be small relative to the size of the foreign exchange
market itself. Second, given that any positive effects are short term, and then
market forces come to dominate, central bankers probably should consider very
carefully whether this use of their reserves is appropriate.
Central bankers in the developed world appear to have moved away, or are
moving away, from foreign exchange intervention. Before we give up on this type
of policy we should recognize that there might be situations associated with
unusual and extreme market aberrations where intervention might be justified for
very short term effects. Since this is a possibility, we should not rule out the use
of central bank interventions in the future.