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The authors are grateful for comments from Stanley Fischer, Toshitaka Sekine, Masahiko Takeda, and members of the IMF’s “Japan Team”. This paper will be presented at NBER’s “Japan Project” conference in Tokyo in September 2000.
Dominguez and Frankel (1993), for instance, use an augmented portfolio balance model, incorporating exchange rate expectations, to show that interventions had a statistically significant impact on exchange rates in the post-Plaza Accord period; interventions are also shown to have mattered during 1982-84, when skepticism about the effectiveness of interventions was pervasive. See, also in this context, Dominguez (1998).
Research at the IMF during this period, for instance, indicated that Japan’s external balances throughout 1985-90 responded to exchange rate changes in broadly the same way that they do in other countries, and in a pattern that was broadly consistent with estimated econometric relationships. See, in this context, Corker (1989) and Meredith (1993).
The recent technical changes in the financing of foreign exchange interventions—the sale of Finance Bills issued by the Ministry of Finance to the public rather than to the BoJ directly—has made no effective difference to how interventions are ultimately financed.
See Cross (1998) for a more detailed description of how foreign exchange interventions are carried out in the United States.
Given the discrete nature of the intervention variables and their dependence on past exchange rates (as modeled below), an explicit incorporation of their future expectations would make the model highly non-linear and intractable (see Pesaran and Samiei, 1995).
ADF tests of order 12 including an intercept and a linear trend gives a value of –1.67 for the logarithm of the exchange rate and –2.83 for the interest rate differential, against a critical value of –3.42. ADF tests on first differences of the two variables gives -10.63 and –11.58, respectively, against a 95 percent critical value of –3.42.
This result holds even when the cany-trade-dummy—which contributes significantly to the value of the R-squared—is excluded. While the inclusion of this dummy variable is justified on economic and statistical grounds, it cannot be treated as a genuine explanatory variable, given that it is defined ex post.
The alternative of including the square of the residuals instead of their absolute value caused computational difficulties.
In particular, the absence of clear support for the interest rate parity hypothesis has no bearings for the short-run model, and removing the error-correction term from the equation makes little difference to the estimation results.