When do central banks prefer to intervene secretly?

Abstract

Central banks often intervene secretly in the foreign exchange market. This secrecy seems to be at odds with the signalling channel. In this article we will analyse when a central bank intervening in the foreign exchange rate market purely through the signalling channel would prefer to act secretly or publicly. By using a microstructure model, we will show that the consistency of the intervention with fundamentals, the volume of noise trading, the weight given to the effectiveness of intervention and the degree of superior information held by the central bank will influence the decision to intervene secretly or publicly. Copyright © 2008 John Wiley & Sons, Ltd.

Can Secret Intervention Be Compatible With a Non‐profitmaking Central Bank and a Fundamental‐consistent Target?

“…There is one distinct difference between the microstructure framework of Vitale (1999) and Ferré and Manzano (2009) and the rational expectations macroeconomic model of this article. In the former, the total market order is the sum of orders from the central bank and noise traders, respectively, and has no influence on the fundamental exchange rate.…”

“…Ferré and Manzano (2009) extend Vitale's (1999) framework by adding a fundamental exchange rate target. They show that if the intervention is consistent with the fundamentals (where the variance of the non‐fundamental part of the target is zero), secrecy will provide a higher expected profit, so that the central banks' profitability motivation can offer a rationale for their secret intervention 13 .…”

“…Because the irregular disturbance d t is unpredictable, it is reasonable to make a conjecture that the market participants' 22. On the other hand, Ferré and Manzano's (2009) corollary 5 states that a more volatile volume of noise trading makes the speculative profits dominate the losses and thus the bank prefers to intervene secretly. rational expectation of e t+1 is: E t e t+1 = −(λγ/δ 2 ) − (E t f t+1 /δ) (A3) = −(λ/δ 2 )(γ + δ) − (E t f t /δ).…”

“…Vitale (1999) and Ferré and Manzano (2009) assume that the bank intervenes under a trade‐off between gaining speculative profits and stabilizing the exchange rate. The two extremes of their intervention consideration are the pure speculator and the pure target.…”