Identifying the Efficacy of Central Bank Interventions: Evidence from Australia and Japan
The endogeneity of exchange rates and intervention has long plagued studies of the effectiveness of central banks’ actions in foreign exchange markets. Researchers have either excluded contemporaneous intervention, so that their explanators are predetermined, or obtained a small, and typically incorrectly signed, coefficient on contemporaneous intervention. Failing to account for the endogeneity, when central banks lean against the wind and trade strategically, will likely result in a downward bias to the coefficient on contemporaneous intervention.
We use an alternative identification assumption, a change in central bank intervention policy, that allows us to estimate, using simulated GMM, a model that includes the contemporaneous impact of intervention. We apply our method using intervention data from the Reserve Bank of Australia and the Bank of Japan. There are three main results. Our point estimates suggest that central bank intervention potentially has an economically and statistically significant contemporaneous effect. For Australia we find a $US100m purchase of the domestic currency will appreciate the exchange rate by 1.3 to 1.8 per cent. This estimate is similar to that from Dominguez and Frankel (1993c), but larger than previous empirical findings. Our point estimate for Japan is smaller with a $US100m purchase appreciating the yen by just 0.2 per cent, but interpretation must consider the substantially larger size of interventions conducted by the Bank of Japan. Secondly, the vast majority of the effect of an intervention on the exchange rate is found to occur during the day in which it is conducted, with only a smaller impact on subsequent days. Finally, we confirm that central bank intervention policy can typically be characterized as leaning against the wind.