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© 2022 International Monetary Fund
WP/22/158
IMF Working Paper
European Department and Monetary and Capital Markets Departments
Exchange-Rate Swings and Foreign Currency Intervention
Prepared by Andrew Filardo, Gaston Gelos, and Thomas McGregor1
July 2022
IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
ABSTRACT: This paper develops a new approach for exploring the effectiveness of foreign currency intervention, focusing on real exchange cycles. Using band spectrum regression methods, it examines the role of macroeconomic fundamentals in determining the equilibrium real exchange rate at short-, medium-, and low frequencies. Next, it assesses the effectiveness of FX intervention depending on the degree of cycle-specific misalignments for 26 advanced- and emerging market economies, covering the period 1990–2018, and using different techniques to mitigate endogeneity concerns. Evidence supports the hypothesis that central banks can lean effectively against short-run cyclical misalignments of the real exchange rate. The effects are present in quarterly data—i.e., at policy-relevant horizons. The effectiveness of intervention rises with the size of the misalignment, and with the duration of one-sided interventions. FX sales appear to be somewhat more effective than FX purchases, and intervention is less effective in more liquid FX markets.
| JEL Classification Numbers: | F31, F37, E58, E32 |
| Keywords: | Foreign exchange intervention, real exchange rates, equilibrium exchange rate, classical cycles, central banking, band spectrum regression. |
| Author’s E-Mail Address: | ajf2019@stanford.edu; GGelos@imf.org; TMcGregor@imf.org |
| JEL Classification Numbers: | F31, F37, E58, E32 |
| Keywords: | Foreign exchange intervention, real exchange rates, equilibrium exchange rate, classical cycles, central banking, band spectrum regression. |
| Author’s E-Mail Address: | ajf2019@stanford.edu; GGelos@imf.org; TMcGregor@imf.org |
Contents
I. Introduction
II. Data Description
III. New Approach to Measuring Exchange Rate Misalignments
A. Exchange Rate and Their Macroeconomic Fundamentals at Different Cyclical Frequencies
B. Identifying Short-, Medium-, and Long-Cycles
C. Relationship of Cycle-Specific Exchange Rates and Macroeconomic Fundamentals
D. Defining Cycle-Specific Exchange Rate Misalignments
IV. Estimates of FXI Effectiveness Using Cycle-Specific Misalignments
A. Baseline Panel Regression Model
B. Baseline Results
C. Addressing the Endogeneity Bias Challenge
D. Robustness
E. Effectiveness of Persistent, Large, and One-Sided Interventions
F. Delving Into the Cross Section
G. Market depth and liquidity
V. Conclusions
VI. References
FIGURES
1. Exchange Rate Intervention (FXI), by Country From 1990–2018
2. Cyclic-Specific Exchange Rate (REER) Misalignments
3. FXI Surprise and Capital Flow IVs
4. Cyclical Exchange Rate (REER) Misalignments
5. FX Sales vs. Purchases
TABLES
1. First-Stage Regression Model of Exchange Rate Macro Fundamentals
2. Effectiveness of Leaning Against the Wind
3. Robustness Checks
4. Persistent and One-Sided Interventions
5. Large Interventions (Sales vs Purchases)
6. Country Differences, by Regions and FXI Intensity
7. Market depth and liquidity
APPENDIXES
A: Data Details
B: Foreign Exchange Intervention Proxy
C: Supplementary Exchange Rate Figures
D: Historical Overview – Evolving views on FX intervention, post-Bretton Woods
The authors would like to thank Gustavo Adler, Suman Basu, Luis Brandao-Marques, Kodjovi Eklou, Olamide Harrison, Henry Hoyle, Jesper Lindé, Nicolás Magud, Prachi Mishra, Rui Mano, Yuan Rollinson, and Yiqun Wu for helpful comments.