Evaluating Foreign Exchange Market Intervention: Self-Selection, Counterfactuals and Average Treatment Effects

Abstract

Abstract:Studies of central bank intervention are complicated by the fact that we typically observe intervention only during periods of turbulent exchange markets. Furthermore, entering the market during these particular periods is a conscious "self-selection" choice made by the intervening central bank. We estimate the "counterfactual" exchange rate movements that allow us to determine what would have occurred in the absence of intervention and we introduce the method of propensity score matching to the intervention literature in order to estimate the "average treatment effect" (ATE) of intervention. Specifically, we estimate the ATE for daily Bank of Japan intervention over the January 1999 to March 2004 period. This sample encompasses a remarkable variation in intervention frequencies as well as unprecedented frequent intervention towards the latter part of the period. We find that the effects of intervention vary dramatically and inversely with the frequency of intervention: Intervention is effective over the 1999 to 2002 period, ineffective during 2003 and counterproductive during the first quarter of 2004.

When Is Foreign Exchange Intervention Effective? Evidence from 33 Countries

“…A matching approach. This approach involves selecting suitable counterfactuals by a matching mechanism to account for market circumstances (see Fatum and Hutchison, 2010). We build on this idea to match actual intervention events and placebo events, and yield a treatment and a control group.…”

Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework

“…Among notable papers, Fatum and Hutchison (2003) in a careful event study analysis of German and the U.S. find that interventions do indeed affect the exchange rate. However, for Japan, the same authors find that only sporadic and relatively infrequent intervention is effective (Fatum and Hutchison 2010). More recent studies have began to look at emerging markets.…”

The Relative Effectiveness of Spot and Derivatives Based Intervention: The Case of Brazil

“…Finding appropriate instruments for the two FXI terms is particularly challenging in our setup as candidate terms not only need to fulfill standard requirements for instruments; it is also essential that they allow identifying separate reaction functions that are sufficiently distinct to permit including the two modes of intervention jointly in our regressions. In part following the literature on spot interventions (see, inter alia, Ito andYabu, 2007, Fatum andHutchison, 2010), we include the following terms in our vector of instruments: (i) lagged trend exchange rate volatility, (ii) lagged exchange rate deviations from trend, (iii) lagged one year moving average of the exchange rate, (iv) the change in the monetary policy rate, (v) trend spot and futures intervention, and (vi) lagged trend FX flows. 15 The first three terms capture the hypothesis that central banks react to exchange rate developments in various forms.…”