signaling hypothesis
TRANSCRIPT
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FOREIGN EXCHANGE INTERVENTION AND FUTUREMONETARY POLICY: SOME EMPIRICAL EVIDENCE
ON SIGNALING HYPOTHESIS
K.G. Sahadevan, Ph.DAssociate Professor
Indian Institute of ManagementPrabandh Nagar, Off Sitapur Road
Lucknow 226 013INDIA
E-mail: [email protected]: 0522-361889
Fax: 0522-361840
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FOREIGN EXCHANGE INTERVENTION AND FUTURE
MONETARY POLICY: SOME EMPIRICAL EVIDENCEON SIGNALING HYPOTHESIS
*
ABSTRACT
The present study attempts to examine the following questions in the Indian context. Has foreign
exchange intervention been successful in stabilizing exchange rate? Has the intervention been
sterilized with the objective of maintaining monetary target? Does intervention signal changes infuture monetary policy variables? The estimates of the intervention and sterilization equationsindicate that the central bank sterilizes a major portion of reserve flow, and purchases US$ when
its price in terms of rupee is low and vice versa. The estimates of the money supply process show
that purchases (sale) of US$ are correlated with expansionary (contractionary) monetary policyin the future. However, the results from Granger test of causality indicate that intervention does
not have any significant causal relationship with monetary variable and exchange rate.
Keywords: Exchange rate; Central Bank Intervention; Monetary Policy
JEL Classification: F31; E58
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The non-sterilized interventions, on the other hand, change the monetary aggregates and
interest rates due to which exchange rates would be affected in the same way as the
domestic open market operations do. The signaling hypothesis proposed by Mussa
(1981) has given a new dimension to this issue triggering voluminous research in recent
times. It says that foreign exchange intervention is an effective and predictable signal of
monetary policy actions. He has argued that interventions induce traders in the market to
alter their expectations of future monetary policy or long-run equilibrium value of the
exchange rate. When the market revises its expectations of future money supplies, it also
revises its expectations of the future spot exchange rate, which in turn brings about a
change in the current rate. In this theoretical setting the present paper seeks to answer the
following questions empirically. Has foreign exchange intervention been successful in
stabilizing exchange rate? Has the intervention been sterilized with the objective of
maintaining monetary target? Does intervention signal changes in future monetary policy
variables? These questions have been examined empirically in the Indian context using
monthly data on Reserve Bank of Indias (RBI) foreign exchange intervention from June
1995 through May 2001.
The remainder of the paper is organized into four sections. Section II briefly reviews the
literature on the effectiveness of foreign exchange intervention. Section III carries a
description on the international perspective of nature and purpose of intervention. The
formulation of testable hypothesis and the equations for estimation have been discussed
in section IV and section V presents results of the study and discussion. Section VI
concludes the findings of the study. A description on data and variables, and
methodology of the study has been presented as appendix.
II. REVIEW OF PREVIOUS STUDIES
There is extensive literature on the effect of foreign exchange market intervention on
exchange rate and future monetary policy variables.2 However, there has been very little
evidence to suggest that intervention consistently and directly affects spot exchange rates,
through either monetary, or a portfolio balance transmission channel [Baillie., et al,
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(2000)].3 Most of the studies in this area are in the US context and are concerned with
the effect of intervention on the US$ exchange rates against Japanese Yen and German
Mark. These Studies differ in the methodologies used. Three different methodologies
have been utilized for empirical investigation. First, there are attempts to measure the
effect of current intervention on the exchange rate over and above the contribution of the
current fundamental. Secondly, the most common method has been the estimation of
money supply process (equation 2 below) and measurement of the ability of intervention
to predict the future course of money supply. The third approach, which has been used in
Fatum and Hutchison (1999), is to directly estimate the effect of intervention on changes
in expected monetary policy.
The findings of Dominguez and Frankel (1993) have supported the effect of Federal
Reserve and Bundesbank intervention on exchange rate through the portfolio channel as
against the consensus view thus far that the portfolio channel of intervention had been
ineffective. Similarly, the findings of Ramaswamy and Samiei (2000) on the basis of a
simple forward looking model of the exchange rate showed that interventions conducted
during 1995-99 succeeded in changing the path of the yen-dollar rate in the desired
direction. The results from probit model indicated that the Bank of Japan (BoJ) had
pursued a symmetrical policy by which both an excessive appreciation and depreciation
of the yen provoked interventions, and that interventions in the yen-dollar market tend to
occur in clusters. In the context of UK, Kearney and MacDonald (1986) have examined
the potency of sterilized intervention using a portfolio balance model the result of which
indicated that sterilized intervention had been effective on British pound-US$ exchange
rates.
The evidences from most of the studies are in favor of signaling channel, which reveals
the monetary policy intentions of the central bank through interventions. The portfolio
channel through which sterilized intervention affect exchange rates, on the other hand,
has received little empirical support. Using bivariate vector autoregressions and Granger-
causality tests, Lewis (1995) has examined whether intervention helps predict future
changes in monetary policy in the US context. The study reports a mixed picture of the
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signaling story and finds a circular relationship between intervention and future monetary
policy. Kaminsky and Lewis (1996) have also reported similar results, which indicate
that the US intervention provided a signal to future changes in interbank rates and
monetary aggregates, but sometimes in the opposite direction of that predicted by the
conventional signaling hypothesis. Ghose (1992) tested the portfolio balance channel by
examining the effects of changes in relative asset supplies on the US$-Deutschemark rate
and found a weak, but statistically significant, portfolio balance influence on the
exchange rate. In Fatum and Hutchison (1999), the evidence obtained from GARCH
model found dollar intervention not related to a rise in expected future short-term interest
rates (monetary tightening). They have used the federal funds futures market prices as
the proxy for market expectations on future monetary policy.
Over the past few years, attention has been shifted to studying the effect of intervention
on exchange rate volatility. On the whole, the evidence from these studies on impact of
intervention on conditional exchange rate volatility as well as on implied volatility is not
very conclusive. Aguilar and Nydahl (2000) reported results from GARCH models that
central banks sterilized intervention has not systematically reduced the volatility of
Swedish kroner rates against US$ and Deutsch Mark. The evidence presented in Bonser-
Neal (1996) on the Federal Reserves intervention suggested that the central bank
intervention had little effect on volatility. Using the Friedmans profit test4Andrew
and Broadbent (1994) tested the effectiveness of the Reserve Bank of Australias (RBA)
intervention and showed that RBA has made significant profits from intervention and that
intervention has tended to stabilize the Australian dollar exchange rate over the period the
currency has been floating. The nonavailability of data on the rate and volume of intra-
day sale and purchase of foreign currency undertaken by any central bank however limit
the feasibility of profit test. The study has also used the Wonnacotts criterion5the result
of which supported the findings of profit test. Kim et al (2000) came out with similar
evidence in the Australian context by showing that sustained and large interventions have
a stabilizing influence in the Australian $-US$ market in terms of direction and volatility
during 1983-97. Galati and Melick (1999) studied the impact of the Federal Reserves
and BoJs intervention on the instantaneous and expected volatility (derived from option
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prices) of yen-US$ exchange rates and found that the interventions did not have any
impact on the forward rates but suggested that it could increase the uncertainty in the
movement of spot rates. However, Baillie and Osterberg (1997) found some evidence
that intervention leads to increases in volatility and also influences the risk premium in
the Deutschemark-US$ and Yen-US$ forward markets. They have also reported that
intervention is Granger caused by high volatility of changes in the nominal exchange rate
and unidirectional from intervention to risk in the forward market. They have concluded
that intervention is motivated by increases in spot rather than forward market volatility.
To conclude, there is no general consensus evidence to support the portfolio balance
channel. However, there is some, but no conclusive evidence that intervention mainly
works through the signaling channel, i.e., by the central bank conveying a signal to
market participants about information on future fundamentals that they do not have. In a
fairly comprehensive survey of research Baillie et al (2000) concluded that empirical
work to date suggests that exchange market intervention does not directly affect the
fundamental economic determinants of exchange rates, but allows for the possibility that
intervention may sometimes influence market expectations about those fundamentals.
III. INTERVENTION UNDER FLOATING SYSTEM
In its true sense, no currencies in the world are freely floated. Since the beginning of
floating exchange rate system in 1973, most of the worlds major central banks have
intervened frequently and at times forcefully in the foreign exchange markets to influence
the path that their respective currencies have taken. Although there are no well defined
rules governing the motive of intervention, the IMFs Principles for the Guidance of
Members Exchange Rate Policies describes that a member should intervene in the
exchange market if necessary to counter disorderly conditions which may be
characterized inter aliaby disruptive short-term movements in the exchange value of its
currency. In the Indian context, in addition to the trade and capital controls imposed by
the government, the Reserve Bank of India (RBI) uses its foreign exchange reserves for
market intervention so as to align the market rate of rupee with its desiredrate consistent
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with certain macroeconomic parameters. This official exchange rate management has a
conventional objective of ensuring the currency not deviating far away from the long-run
equilibrium rate. However, other considerations like maintaining export competitiveness,
guarding currency against speculation, etc., often outweigh this objective and necessitate
official intervention to lean against the wind of short-term exchange rate movements.
Though the direct intervention alters the demand and supply forces in the market which,
lead to correction in exchange rates in the short-term, its effectiveness however depends
on the volume of intervention relative to the daily turnover in the market. The market
intervention has various implications, and it is designed to fulfill certain intentions of the
central bank depending on the choice between sterilized intervention and non-sterilized
intervention. The sterilized intervention through open market operations offsets the
change in net foreign assets by a corresponding change in net domestic assets. This in
turn helps the central bank to adhere to monetary targets. RBI at times resorts to
sterilized intervention not essentially to directly affect exchange rate but to give signal in
two counts. First, it signals the intention of the central bank to control the monetary
growth and secondly, it signals the undesirable changes in exchange rate that are being
taken place in the marketplace. These signals eventually force traders with vulnerable
long or short positions to abort speculation and bring exchange rate in alignment with its
long-run trend rate or to maintain the rates at a desired level. The non-sterilized
intervention, on the other hand, creates a mismatch between supply of and demand for
money eventually leading to change in exchange rate in the medium term. This
intervention is effective only if its volume is sizable relative to the outstanding stock of
domestic money holding. However, most studies conclude that the direct effect of
intervention on exchange rates is either statistically insignificant or quantitatively
unimportant [Rosenberg (1996)].6
The objectives of intervention differ by country and from one period to the other. The
BoJ has consistently pursued a policy of leaning against the wind. Whenever yen raised
against the dollar, the BoJ bought dollars and sold yen to moderate the yens rise; and
vice versa. While BoJ intervenes in order to moderate the trends in yen over time, the
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Bundesbank does intervene primarily for domestic monetary control. However, at times,
Bundesbank has compromised this objective in order to get the exchange rate in
alignment with its long-run rate.7 In the case of dollar however Federal Reserve has
never maintained a uniform policy for exchange rate management. While during 1978-
80 it carried out major intervention to arrest dollars decline, the period between 1981
and 1984 witnessed benign neglect toward dollars rise. In line with the Plaza Accord
dollar was encouraged to decline during 1985-86 while during 1987-92 Federal Reserve
promoted greater stability of dollar in line with Louvre Accord. From 1993 onward,
Federal Reserve has encouraged the dollar to decline.
IV. THE SIGNALING HYPOTHESIS
Mussa (1981) has proposed that interventions are the indications to future course of
monetary policy. Such signals could be particularly credible, since intervention would
give the monetary authorities an open position in a foreign currency that would result in a
loss if they failed to validate their signals. According to this signaling hypothesis, central
bank may signal contractionary (expansionary) future monetary policy by selling
(buying) the intervention currency in the foreign exchange market today. Therefore, the
current sterilized intervention alters market perception about the future course of
monetary policy according to which exchange rate will move even though sterilized
intervention currently offsets the monetary effects. This signaling channel signifies that
there is asymmetry of information between the central bank and the market participants
on future fundamentals of the exchange rate.
The signaling hypothesis may be illustrated by a standard asset-pricing-model approach
to exchange rates.
In the above process for nominal exchange rate, st is the log exchange rate at time t, ft
represents the current period fundamentals, Et is the expectations operator, and is a
( ) ( )101
jtf
tE
j
jt
s+
==
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discount factor. Following the monetary models of exchange rate, the current exchange
rate is the expected present discounted value of differences in the relative monetary
conditions which are the fundamental determinants of exchange rates.8 Given the
hypothesis that intervention at time t-k, nt-k help predict the future value of the
fundamental determinant which follows a simple autoregressive process with the
intervention signal entering exogenously together with a random disturbance term (t),
the process of fundamental is given by
where fis the autoregressive coefficient of fon its own lag and is the coefficient of kperiod lagged intervention. The variable n being the central banks net purchase of
foreign currency (US$) its coefficient would assume a positive value for the signaling
story is to be right. It signifies that the purchase of foreign currency (which is equivalent
to sales of domestic currency) at t-ksignals an expansionary monetary policy in the future
at time t. Similarly, the sale of foreign currency will be correlated with a tight monetary
policy in the future. Some of the studies as explained earlier however have utilized the
direct approach of estimating the following equation.
whereEt+1ft+j Etft+jrepresents changes in expected fundamentals.
The present study has mainly estimated the fundamental process (2) using broad money
as the proxy for fundamental and measured the ability of intervention in terms of the
estimate to forecast movements in the fundamental (expected monetary policy is being
considered as the fundamental). The hypothesis is that the purchase (sales) of US$
against rupee invokes the expectation of monetary expansion (tightening).
)2(1 tkt
nt
fft
f +
+
=
( )3101 ttn
jtf
tE
jtf
tE ++=
+
++
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V. EMPIRICAL TEST AND DISCUSSION OF RESULTS
The table-1 and 2 contain the results of various tests. The frequency table and the 2test
indicate that intervention and exchange rates are interdependent. But the movement of
exchange rate has not largely been in the direction that intervention ideally leads to. It is
observed that in 48 cases out of 70 data points rupee appreciated (depreciated) when RBI
was the net buyer (seller) of US$ while it moved in the expected direction in only 22
cases. Moreover, it would be interesting to note from the figure-1 that the exchange rate
remained more or less stable during 1996:4 1997:10 and 1998:8 2000:4 when RBI
continued to be the net buyer of US$ from the market during the former period while it
was not a consistent buyer during the later period. As the figure shows, RBI has turned
out to be a net buyer of US$ when rupee was sliding. For instance, between October
1998 and March 1999 rupee depreciated from 42.25/US$ to 42.43/US$ while RBI has
undertaken a net purchase of dollar to the tune of Rs. 10,879 during this period. Thus the
visual examination of the exchange rate and intervention data essentially indicates the
fact that intervention has not been aiming at maintaining exchange rate or alternatively it
has not been sufficient enough to pull the exchange rate in desired direction.
The test of central banks policy of leaning against the wind has been carried out byestimating an intervention equation. A positive coefficient for exchange rate in the
intervention equation is an indication of the practice of leaning against the wind which
means that central bank prevents further appreciation (depreciation) of rupee by purchase
(sale) of US$. The statistically significant and negative coefficient of exchange rate
(Rs./US$) in the intervention equation signifies that the central bank purchases US$ when
its price in terms of Indian rupee is low and vice versa. However, the variation in
monetary base found to have insignificant influence on the intervention decisions.
The figure-2 further confirms the fact that exchange rate (and intervention) does not
reflect the monetary conditions. Ideally, if the transmission mechanism works, the
monetary growth and currency value should move in opposite directions i.e., positive
growth in money supply should be offset by depreciation of exchange rates. The period
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of stable exchange rate between March 1993 and August 1995 has been the period of
wild fluctuations in money supply growth ranging between 14 per cent to as high as 22
per cent. In spite of this, rupee remained relatively stable at around 31.50/US$ until
August 1995. In September 1995, rupee closed at 34.00/US$ and subsequently remained
stable at around 35.00/US$ until July 1997. A tighter monetary policy during 1995-97
has brought down the growth of money supply to around 16 per cent on an average.
Further, rupee depreciated subsequently to move from 36.50/US$ to 42.50/US$ between
August 1997 and June 1998, and thereafter it was stabilized. Though money supply has
not grown beyond 16 per cent during this period, the fall in rupee value was on account
of declining capital inflow and weak export growth.9
Following Genberg (1976), a standard sterilization equation has been estimated to see
what extent the central bank sterilizes reserve flows. The estimated coefficient values of
foreign currency reserves (sterilization coefficient) and central banks net credit to
government in the sterilization equation capture the thrust of monetary policy to sterilize
the impact of reserve flows on monetary base. Under complete sterilization, the
coefficient of reserves would be 1 and in the absence of sterilization its value would be
zero. However, the estimated sterilization coefficient is 0.23, which signifies that RBI
sterilizes a major portion of reserve flow. There is some supporting evidence to the
signaling hypothesis as well. The test of signaling hypothesis is based on the estimates of
the equation (2) in which money supply is being used as a proxy for the fundamental
factorft. The positive coefficient of lagged intervention signifies that purchases of US$
are correlated with expansionary monetary policy. A very low coefficient value of
lagged intervention in the estimated equation indicates that it has only a marginal impact
on money supply. The direct approach of testing signaling hypothesis using equation (3)
has also not provided substantive evidence to confirm that intervention signals future
monetary conditions.
The results from test of causality indicate that intervention does not have any significant
causal relationship with monetary variable and exchange rate. However, the result shows
that, as expected, intervention causes changes in the level of foreign currency reserves.
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This gives an indication to the fact that RBI has not been buying (selling) dollars when
rupee becomes stronger (weaker) and reserve level rises (falls).
VI. Conclusion
The present study has attempted to empirically examine the impact of central banks
intervention on exchange rate and future monetary policy in the Indian context. It is
emerged from the analysis that the intervention did not have stabilizing effect on
exchange rate. On the contrary, the result showed that the central bank accumulates
foreign currency when it is cheaper and offloads when it is dearer in terms of domestic
currency. The central bank however has used intervention, though not very significantly,
for signaling future course of monetary policy. To conclude, any study in the above
directions would ideally use the daily exchange rate and intervention data. The monthly
data as has been utilized by the present study owing to the non-availability of daily
intervention data limited the results of the study to certain extent.
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Table-1: 2Test and Estimated Regression Equations
2Test
Number of months that Rs./US$ rateAppreciated when RBI is net buyer of US$ 23Depreciated when RBI is net buyer of US$ 22Appreciated when RBI is net seller of US$ 0Depreciated when RBI is net seller of US$ 25
Total 70
Chi-square 19.1*
Estimated Regression Equations
Intervention equation
nt = + 1st+ 2 bt + t0.14 -4.42 1.76
(0.44) (-2.01)** (1.23)
R2= 0.21 SEE = 0.29 D-W = 2.01 = -0.36(-3.04)
Sterilization equation
bt = + 1rt + 2gt + t0.003 0.24 0.27(0.96) (3.51)* (4.79)*
R2= 0.31 SEE = 0.02 D-W = 2.20
Test of Signaling Hypothesis
1. mt = + 1mt-1 + 2nt-1+ t0.02 -0.043 0.01
(7.41)* (-0.36) (1.90)***
R2= 0.05 SEE = 0.008 D-W = 2.01
2.
mt+1 mt = + 1nt+ t0.01 0.01(13.5)* (1.88)***
R2= 0.05 SEE = 0.008 D-W = 2.09Refer appendix for definition of variables and their notations.D-W is the Durbin-Watson statistic and values in parentheses indicate t-statistic.One, two and three asterisks indicate significance at 1%, 5% and 10% levels respectively.
is the first order autoregressive parameter.
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Table-2: Results of Granger Causality Test
mt-1 mt-2 nt-1 nt-2
mt -0.05 (-0.38) -0.029 (-0.23) 0.01 (1.67) -0.0004 (-0.106)nt 2.33 (0.49) -1.74 (-0.37) -0.41 (-3.11) -0.12 (-0.90)
P-value for ntcauses mt: 0.18, F-statistic F(2, 64)= 1.77
P-value for mtcauses nt: 0.82, F-statistic F(2, 64)= 0.196
rt-1 rt-2 nt-1 nt-2
rt -0.56 (-3.60) 0.20 (1.17) 0.067 (3.54) 0.029 (1.74)nt -3.63 (-2.74) -0.58 (-0.40) -0.14 (-0.85) 0.07 (0.47)
P-value for ntcauses rt: 0.003, F-statistic F(2, 64)= 6.53P-value for rtcauses nt: 0.024, F-statistic F(2, 64)= 3.94
st-1 st-2 nt-1 nt-2
st 0.19 (1.44) -0.20 (-1.58) -0.006 (-0.96) 0.002 (0.31)
nt 0.013 (0.005) 1.19 (0.454) -0.389 (-2.95) -0.098 (-0.741)
P-value for ntcausesst: 0.49, F-statistic F(2, 64)= 0.732P-value forstcauses nt: 0.899, F-statistic F(2, 64)= 0.106
The values in parentheses indicate t-statistic.
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Figure 1: RBI's Intervention and Exchange Rate Movements
-7500
-2500
2500
7500
12500
17500
199
5
6
199
5
8
1995
10
1995
12
199
6
2
199
6
4
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6
6
199
6
8
1996
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1996
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2
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4
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8
1997
10
1997
12
199
8
2
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4
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8
6
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8
1998
10
1998
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9
6
199
9
8
1999
10
1999
12
200
0
2
200
0
4
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0
6
200
0
8
2000
10
2000
12
200
1
2
200
1
4
Year and Month
US$PurchasebyRBI
(inRs.
Crore)
0
5
10
15
20
25
30
35
40
45
50
Rs/US$exchangerates
Rs/US$ rates
US$ Purchase
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Figure 2: Monetary Growth and Exchange Rates
10
15
20
25
30
35
40
45
50
1995
6
1995
9
1995
12
1996
3
1996
6
1996
9
1996
12
1997
3
1997
6
1997
9
1997
12
1998
3
1998
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1998
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1998
12
1999
3
1999
6
1999
9
1999
12
2000
3
2000
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2000
9
2000
12
2001
3
Year and Month
Rs/US$Rates
10.00
12.00
14.00
16.00
18.00
20.00
22.00
24.00
M3 growth
Rs/US$ rates
M3growthrates
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ENDNOTES
1. In the Indian context, Reserve Bank of India uses US$ as the intervention currencywhich is being bought and sold against Indian rupee in the market.
2. There are also studies, e.g., Neely (2000) which deal with mechanics, timing,instruments and purpose of secrecy of intervention which are not being reviewed
here.
3. This study is the most recent one to offer a fairly comprehensive survey of research inthe area of central bank intervention.
4. Friedman in his seminal work on flexible exchange rate system has argued that acentral bank which was stabilizing the exchange rate would tend to buy foreign
exchange when its price was low, and sell when its price was high, and hence itsoperations would be profitable. Taking the cue from this intervention rule it is argued
that the existence of profits over long periods provides a strong case for the view that
central bank intervention has been effective in stabilizing the exchange rate.
5. The test proposed by Wonnacott (1982) indicates that intervention is stabilizing if itreduces the variance of exchange rate around its trend. It involves measuring whether
the direction of intervention is consistent with pushing the exchange rate back
towards its long-run moving average.
6. Against the consensus view in the early 1980s that central bank intervention isineffective, Dominguez and Frankel (1993) in their seminal study argue that when the
authorities are prepared to intervene at a particular upper or lower limit they will
achieve a higher degree of success in stabilizing the currency with a smaller amount
of intervention if they publicly announce these limits ahead of time. In the light of
these findings, the Committee on Capital Account Convertibility in India headed by
Shri. S.S. Tarapore recommended that a REER-monitoring band be declared to enable
the participants to anchor expectations on when RBI would intervene and when it
would not for making its intervention more effective [Tarapore (1997)].
7. After the formal unification of Europe, Bundesbank implements exchange rate policyand conducts foreign exchange operations consistent with the provisions of Article
109 of the Treaty of European Union.
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8. In the formulation of ft, it is assumed that the growth of money supply in rest of theworld was constant. Therefore,ft represented the change in money supply conditions
in the domestic economy alone.
9. The impact of monetary policy on the behavior of rupee exchange rate andinternational reserves in the Indian context has been empirically examined in
Sahadevan (1999) using Girton-Roper model of exchange market pressure.
APPENDIX
Definition of Variables and Methodology of the Study
The present study has been carried out on monthly data for a period starting from June
1995 through May 2001. The choice of starting period of the sample coincides with the
availability of data on RBIs intervention. The variables used in the study are defined as
follows: reserve money (b), broad money (m) i.e. M1 plus time deposit liabilities of
banks, foreign exchange reserves (r) is the rupee value of foreign currency assets with
RBI, exchange rate (s) is the monthly average rate of the rupee vis--vis US$ which is
measured in rupees per unit of US$, and central banks net credit to government (g) is the
central governments net borrowings from RBI. The intervention variable (n) is the rupee
equivalent of monthly net purchase (positive values)/net sales (negative values) of US$
by the Reserve Bank of India in the spot and forward segments. The sources of data are
RBI BulletinandRBI Handbook of Statistics on Indian Economy.
The ordinary least square (OLS) method is used for estimating the equations specified in
section IV. The possibility of serial correlation problem has been verified by using
Durbin-Watson test statistics the values of which are reported against all estimated
equations. In those cases where serial correlation is detected, the coefficient estimatesare adjusted by using Cochrane-Orcutt method and the first order autoregressive
parameter () is reported along with its t-statistics. The causality between intervention,
monetary variable and foreign exchange reserves has been tested using Granger test
which is based on a simple logic that a variable Yis caused by X if Y can be predicted
better from past values of YandXthan from past values of Yalone.
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LITERATURE CITED
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Andrew, Robert and John Broadbent., Reserve Bank operations in the foreign exchangemarket: effectiveness and profitability, Research Discussion Paper 9406, InternationalDepartment, Reserve Bank of Australia, November 1994.
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