(topic 6) japan's sterilized fx intervention

7/30/2019 (Topic 6) Japan's Sterilized FX Intervention

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STERILIZED FX INTERVENTION:

THE EXEPERIENCE OF JAPAN

SHARON CHOO | DIV TENG | SHAUN CHIA | TEE BENJAMIN


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CONTENT OUTLINE

1) Key Issues relating to sterilized FX intervention

2) Japans experience in using sterilization

- Approach taken through history- Effectiveness of Intervention efforts

3) Lessons learnt in exchange rate management

KEY ISSUES JAPANS EXPERIENCE LESSONS ON STERILIZATIONINTRODUCTION


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KEY ISSUES FX STERILIZATION



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WHY USE STERILIZATION?

Objective of Central Bank:

Maintaining Price Stability

Controls money supply

through i/r (minimize inflation)

Managing foreign reserves

(exchange rate)



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HOW IS STERILIZATION DONE ?

CB carries out equal foreign and domestic assettransactions in opposite direction so as to keep

domestic money supply unchanged.


Source: Sarno, Lucio, and Mark P.Taylor. 2001.Official Intervention n the Foreign Exchange Market: Is It

Effective and, If So,How Does It Work? Journal ofEconomic Literature 39(3), pp. 839868.


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3/26/2012KEY ISSUES JAPANS EXPERIENCE LESSONS ON STERILIZATIONINTRODUCTION

HOW IS STERILIZATION DONE ?

Illustration of how

the CB balance sheetis maintained and

effect on Monetary

Base


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THEORETICAL FRAMEWORK1

Sarno & Taylor (2001) sets out two theoretical explanations

for sterilized FX intervention:

1) Portfolio Balance Channel

2) Signaling Channel (Market Expectations)


1Sarno, Lucio, and Mark P.Taylor. 2001.Official Intervention n the Foreign Exchange Market: Is It Effective

and, If So,How Does It Work? Journal ofEconomic Literature 39(3), pp. 839868.


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PORTFOLIO BALANCE CHANNEL

Public sees foreign assets as imperfect substitutes

Following intervention against the YEN (Sell ), public

finds itself holding larger share of YEN assets

At prevailing exchange rates this induces people to sell

extra YEN to rebalance their portfolio

Sale of YEN assets would cause the ER to fall (

depreciates)



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SIGNALING CHANNEL

Intervention conveys a signal that changes public

expectations toward a future exchange rate

Sees signal as reflecting a change concerning future

monetary policy or economic fundamentals

As expectations change, ER moves in tandem


NOTE: As US & Japan maintain unrestricted capital flows, short termsecurities are highly substitutable, giving more credibility to the

signaling channel as the theoretical basis for sterilization.


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FREE MARKET v GOVT INTERVENTION


Should the central bank intervene or let the free

market decide on the exchange rate?

Source of stability or more volatility?

Cost?

Implications?

Impossible Trinity?


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THE JAPANESE EXPERIENCE:

APPROACHES & EFFECTIVENESS



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INSTITUTIONS INVOLVED


BANK OF

JAPAN (BOJ)

MINISTRY OF

FINANCE (MOF)

Determines intervention

policy (FX policy)

Responsible for Fiscal

Policy (Tax + G)

Determines whether

sterilization takes place

Acts as ministrys agent in

conducting actual

sterilization operations


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HOW INTERVENTION IS DONE IN JAPAN


Ministry of Finance raises necessary funds for foreignexchange through sale of short-term government bills.

Yen-funds obtained deposited in FEFSA (foreign exchange

funds special account

BOJ given authority to use funds from FEFSA to carry out

FX market operations

NOTE: As bills are issued before actual FX operations it implies that

Japanese FX intervention activity is automatically sterilized


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OVERVIEW OF JAPANESE INTERVENTION


Source: Data from World Bank: World development Indicators


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OVERVIEW OF JAPANESE INTERVENTION


4 Main Episodes of Japanese Intervention Activity:

1975 1978

1985 1990

1991 1998

2003 2004

STATE OF ECONOMY APPROACH

EFFECTIVENESSOBJECTIVES


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LEARNING TO FLOAT

(1973 1979)



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LEARNING TO FLOAT (1973 1979)


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Collapse of Bretton Woods Fixed ER system in 1971

Appreciation of the YEN from 308 = 1USD (1971) to 250 =

1USD (1977)

Moderate economic growth and accumulation of trade

surpluses

Amidst two oil shocks in 1973 and 1979

STATE OF THE ECONOMY


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First period of prolonged intensive intervention (Selling Yen)

in 1977:

To prevent sharp appreciation of the YEN which crossed

250=1USD in Nov 1977

Coordinated intervention efforts with central banks of

US/Germany & Switzerland in selling Yen.

Pattern reversed in 1979 as YEN began to depreciate with

the second oil shock in 1979

APPROACH


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OBJECTIVES & EFFECTIVENESS

Intervention was small and frequent

To reduce ER volatility and to prevent excessive sudden

appreciation of the YEN.

Successful in smoothing operations, limited in success in

preventing LR appreciation of the YEN.


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FROM PLAZA TO LOUVRE

(1985 1989)



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SECOND PERIOD: 1985 - 1989




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FROM PLAZA TO LOUVRE & BEYOND (1985-1989)


Plaza Accord signed on 22 Sept 1985 to correct

overvaluation of the USD.

Following agreement, YEN appreciated sharply from240=1USD (Sept 1985) to 200=1USD (Nov 1985)


Source: Datastream (London closing rates); Yen/Dollar Exchange rate (16 Sept 13 Dec 1985)


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With sufficient appreciation achieved, authorities attempted

to achieve ER stability without success.

Moved to conclude the Louvre agreement in Feb 1987, withG-6 countries to cooperate closely to stabilize ER

Joint intervention appeared to keep ER within a target zone

(1987) but soon appeared fruitless as the markets no longer

believed the credibility of policy coordination.



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APPROACH

Large, frequent

interventions

37 days (out of 169)

EFFECTIVENESS

Source: IMF, International Financial Statistics

PURCHASE OF $s

Source: Nihon Keizai Shinnun; Funabashi (1988)

Limited in success Ineffective after 1988

Feb Oct 1987


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IMPLICATIONS

During period of appreciation following the Plaza accord, capital

controls were swiftly relaxed:

In May 1987, as they tried to FIX ER within the particular band,

they could not turn to capital controls

Sharp appreciation of the YEN also meant severe deflationary

pressures, forced BOJ to turn to easy monetary policy (Cut I/R) to

stabilize the YEN and expand domestic demand

Policy which was too loose, too fast resulted in asset price

inflation through 1990 and subsequent burst bubble in 1991.


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FRAGILE RECOVERY : (1991 1995) & (1995 1999)




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Following the bursting of the asset price bubble in 1991,

slow economic growth & stagnation

Reduction of I/R from 4.5% in 1991 to 0.5% in 1995 Period characterized by spectacular YEN appreciation from

140=1USD (Apr 1991) to 80=1USD (Apr 1995) and

depreciation back to 146=1USD (Apr 1998)


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APPROACH

Distinct differences in

intervention strategy

before and after 1995.

Before 1995: Small &

Frequent

After 1995: Large &

Infrequent

Coincided with change of

leadership: Dr Sakakibara

Mr Yen appointed in

June 1995Feb Oct 1987



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BEFORE 1995


In March 1995, market pressures forced the YEN to

appreciate beyond the 90 mark, and the authorities

intervened on 21 days out of 23 days.

Despite selling nearly 500 billion YEN, authorities were

unable to keep the YEN from appreciating to 80=1USD.

Swift move of YEN attributed to delta hedge funds

Coincided with auto-trade disputes between Japan & US.


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AFTER 1995


After appointment of Dr Sakakibara, interventions were

less frequent and extremely large in comparison

Intervention conducted in the same direction as the

market v opposing the market

He believed previous efforts failed because of the

predictable nature of the interventions and could not

change market sentiments

On 8th September 1995, authorities made a successful

push to bring the ER across the 100 mark


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APPROACHES TOWARD INTERVENTION


Lean AGAINST the wind strategy

Putting a break on trend of ER movements

a. Reverse the trend

b. Slows down the trend

Lean IN the wind strategy

Intervention in the same direction as the trend

a. Hasten the return to normal level

b. Make sure direction continues


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EFFECTIVENESS

Using a general test criterion:

Whether following an MOF operation, exchange rate moves in

the desired direction or at least slows the movement in the

undesired direction.

First Period Second Period

Days of Intervention 165 days 49 days

Between Interventions 6 days 49 days

Median Amount $348 Million $3,984 Million

% Success 27.9% 51.2%

Source: Chaboud, Alain P. and Owen F. Humpage, An Assessment of the Impact of Japanese Foreign

Exchange Intervention: 1991-2004. Board of Governors of the Federal Reserve System, International

Finance Discussion Papers, No. 824, January 2005.


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THE GREAT INTERVENTION

(2003 -2004)



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THE GREAT INTERVENTION (2003 2004)




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In 2003, the Bank of Japan intervened vigorously to reduce

the value of the YEN.

Motivated by the perception that an excessive rise in theYEN would hinder economic recovery by reducing export

competitiveness

35 trillion YEN sold between Jan 03 and Mar 04

Massive intervention led to a substantial increase in

Japanese foreign reserves to more than $800 billion.



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APPROACH

Unilateral purchase of US$.

Stealth intervention

Extremely large and

frequent

Median amount of $1,753

million

Days between intervention= 3 days

Source: Japanese Ministry of Finance



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EFFECTIVENESS


Relatively successful during first

8 months of 2003 (stability)

However, effects appeared to

be temporary.

LT appreciation of the YEN from

Oct 03 despite greater

intervention

122

115


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OVERALL EFFECTIVENESS OF STERILIZATION

KEY OBSERVATIONS

Success of sterilized Intervention dependent on:

1. Whether intervention was expected

2. Whether intervention was coordinated or unilateral

3. Size of the Intervention

4. Frequency of the Intervention

NOTE: Most of these factors are related to whether sterilization is

able to successfully influence market expectations (Ee)


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COSTS & IMPLICATIONS

How sterilized intervention transcended

to the broader economy

Japan succumbed to international pressures in allowing its

currency to float. Yen appreciated strongly. Relaxation of capital

controls thereafter

Affected Japans exporters competitiveness heavily dependent

on CA of goods (relative profits of exporters drop when

appreciated)

Central Bank conducts sterilized intervention to prevent

appreciation of to help exporters



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COSTS & IMPLICATIONS

What Japan did not foresee

Concurrently to avert a recession, loose monetary policy (I/R)

adopted

Capital inflows and loose monetary policy caused asset bubble

burst

Deflationary pressures in the economy. Citizens have high

propensity to save. Even at I/R near to 0, unable to stimulate

economy

Weak economic growth, deflationary pressures still felt today



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LESSONS IN USING STERILIZATIONTAKEAWAYS FOR JAPAN

IMPLICATIONS FOR CHINA



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LESSONS IN USING STERILIZATION


Lessons: Japans Intervention Experience

If fundamental factors affect the markets view of the ER,

intervention is usually ineffective

Eg Large trade surpluses with US and GDP growth due to

growing Japans export industry

If interventions are predictable in nature, market will adjust

itself to beat the interventions

Expected size and time of intervention


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Lessons: Japans Intervention Experience

Importance of CB in managing the impossible trinity dilemma

Sudden relaxation of capital controls not desirable

Coupled with a decrease in interest rates to stimulate economy

in averting a recession

Loss of control of monetary independence following

decision to float ER and relax capital controls

Double source of pressure for currency appreciation.

Fuels inflation and asset bubble



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Similarities between 70s Japan and present China


Nature of economy Export oriented

ER System Fixed ER with strict capital controls

Current Account

Status

Large and persistent Current Account surpluses

from trade, particularly US

International view on

Real ER (REER)

seen as undervalued

before & followingcollapse of BWS.

International pressures

to revalue ER.

RMB seen as

undervalued.

International pressures

to revalue ER.



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Going Forward: How should China revalue its currency?

Not to succumbed to international pressures

Immediate and steep revaluation of ER dangerous and risky Gradual shift away from current fixed exchange rate intervention

and capital controls as Chinas economy grow

Give up sovereign monetary independence if it decides to adopta free floating currency with free capital movement

Prevents rapid inflation and domestic problems in the country


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Was Japan profitable in its Intervention?

Why no Quasi Fiscal Cost?

Free Capital Flows!

- Boon or Bane?

- Stimulate FDI or cause excessive speculation?


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STERILIZED FX INTERVENTION:

THE EXEPERIENCE OF JAPAN

SHARON CHOO | DIV TENG | SHAUN CHIA | TEE BENJAMIN


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Links


Key Issues Japans Experience Lessons Learnt

Introduction to FX

Sterilization

How Intervention is Done Lessons: Japans

Intervention Experience

Portfolio Balance Overview of Japans

Intervention

- 1975-1978

- 1985-1990

- 1991-1998

- 2003-2004

Similarities: Japan v China

Signaling Channel How should China revalue

its currency

Overall Effectiveness

Costs and Implications


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REFERENCES


Ito, T (2003). Is foreign exchange intervention effective? The Japanese experience in the 1990s. In Monetary

History, Exchange Rates and Financial Markets, Vol. 2, P Mizen (ed.), pp. 126153.

Cheltenham, UK: Edward Elgar.

Fatum, R and M Hutchison (2005). Foreign exchange intervention and monetary policy in Japan,

20032004. International Economics and Economic Policy, 2, 241260.

Fatum R, Hutchison M. (2006). Effectiveness of official daily foreign exchange market intervention operations in

Japan. Journal of International Money and Finance 25: 199219.

Takagi, S. (2008). Managing Flexibility: Japanese Exchange Rate Policy, 1971 2007, Exchange Rate Systems andPolicies in Asia, Stallion Press, Singapore

Chaboud AP, Humpage OF. (2005). An assessment of the impact of Japanese foreign exchange intervention: 1991

2004. Board of Governors of the Federal Reserve System, International Finance Discussion Papers, No. 824,

January.

Sarno, Lucio, and Mark P.Taylor. (2001).Official Intervention in the Foreign Exchange Market: Is It Effectiveand, If So,How Does It Work? Journal ofEconomic Literature 39(3), pp. 839868.

Meyer Claude (2007). Should China revalue its curreny? Lessons from the Japanese Experience Groupe

d/Economie Mondiale, (GEM) , SciencePo, Policy Brief 2008, April

Ito, T. (2007), Myths and reality of foreign exchange interventions: an application to Japan. Int. J. Fin. Econ.,

12: 133154. doi: 10.1002/ijfe.336


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Appendices: BoJ 2011 Intervention



On 11 March 2011, the Thoku earthquake and tsunami

occurred incurring an economic lost of US$235billion

Japan being export oriented needs to maintain a

competitive exchange rate

Japan current account surplus makes it most reliable a

currency to keep in comparison to Euro (debt crisis) and

RMB (wariness on growth sustainability)

http://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-

gloominess-in-europe
http://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europehttp://seekingalpha.com/article/318114-2012-yen-outlook-expecting-strength-from-boj-intervention-gloominess-in-europe


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APPROACH

Unilateral

purchase of US$.

Delayed

announcement

(stealth)

Extremely large

Repeated

attempts


Statistics from http://www.boj.or.jp/en/statistics/pub/boj_st/index.htm/
http://www.boj.or.jp/en/statistics/pub/boj_st/index.htm/http://www.boj.or.jp/en/statistics/pub/boj_st/index.htm/


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EFFECTIVENESS

Only Oct 10 & Sep 11

had an immediate

depreciation of

currency

However objective is to

slow down & provide

direction

2 of 4 remaininginterventions had a

reversal in direction

within 2 months



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IMPLICATIONS

The interest rates per annum remained at 0.3%1

(no monetary independence)

Managing the challenges of the Impossible Trinity:

USD vs Yen

82.4878 (25 Mar 12)


1 I/R from http://www.boj.or.jp/en/statistics/pub/boj_st/index.htm/
http://www.boj.or.jp/en/statistics/pub/boj_st/index.htm/http://www.boj.or.jp/en/statistics/pub/boj_st/index.htm/

(topic 6) japan's sterilized fx intervention

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