Since the introduction of a floating exchange rate for the yen in 1973, pressures on the yen and official intervention in the foreign exchange market have passed through a number of distinct phases. Although the direction of intervention in each case was relatively clear—that is, it was consistent with the intention of moderating the speed of exchange rate movements—evaluation of the response of the magnitude of intervention to pressures on the exchange rate is more difficult to effect. The purpose of this paper is to explore certain methods which might be brought to bear on this essentially quantitative problem using developments in Japan over the period March 1973–October 1976 as a reference. The paper also offers evidence refuting the view that foreign exchange market intervention has aimed at establishing a target level for the yen, rather than at simply moderating the speed of exchange rate change. It is not intended to focus on possible actions by the authorities other than purchases and sales in the foreign exchange market that might also influence exchange rate developments.
To determine the response of intervention to exchange market conditions, it is necessary to investigate the reverse mechanism—the influence of intervention on the exchange rate. Accordingly, the paper also deals with the applicability of various theories of exchange rate determination, including the asset market equilibrium theory, to short-run developments in the yen exchange rate.
Amano, Akihiro, “International Capital Movements: Theory and Estimation,” in International Linkage of National Economic Models, ed. by R. J. Ball (Amsterdam, 1973), pp. 283–328.
Artus, Jacques R., “Exchange Rate Stability and Managed Floating: The Experience of the Federal Republic of Germany,” Staff Papers, Vol. 23 (July 1976), pp. 312–33.
Bergsten, C. Fred, “The Next Steps in International Monetary Reform,” in Hearings of the Subcommittee on International Economics, Joint Economic Committee, U. S. Congress, 94th Congress, 2nd Session (Washington, October 18, 1976), pp. 2–15.
Branson, William H., “‘Leaning Against the Wind’ as Exchange Rate Policy,” paper presented at the Conference on Exchange Market Uncertainty, Geneva, November 28, 1976.
Cooper, Richard N., “IMF Surveillance Over Exchange Rates: A Wider View,” in The New International Monetary System, ed. by Robert A. Mundell and Jacques J. Polak (Columbia University Press, 1977), pp. 69–83.
Dooley, Michael P., and Jeffrey R. Shafer, “Analysis of Short-run Exchange Rate Behavior, March 1973 to September 1975,” International Finance Discussion Paper No. 76, Board of Governors of the Federal Reserve System, February 1976.
Dornbusch, Rudiger, “The Theory of Flexible Exchange Rate Regimes and Macro-economic Policy,” in Flexible Exchange Rates and Stabilization Policy, ed. by Jan Herin and others (Boulder, Colorado, 1977), pp. 123–43. This paper also appeared in Scandinavian Journal of Economics, Vol. 78 (1976).
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)| false Dornbusch, Rudiger, “The Theory of Flexible Exchange Rate Regimes and Macro-economic Policy,”in Flexible Exchange Rates and Stabilization Policy, ed.by and Jan Herin others( Boulder, Colorado, 1977), pp. 123– 43. This paper also appeared in Scandinavian Journal of Economics, Vol. 78( 1976).
International Monetary Fund, Annual Report of the Executive Directors for the Fiscal Year Ended April 30, 1977 (Washington, 1977).
Schadler, Susan, “Sources of Exchange Rate Variability: Theory and Empirical Evidence,” Staff Papers, Vol. 24 (July 1977), pp. 253–96.
Williamson, John, “Exchange-rate Flexibility and Reserves Use,” in Flexible Exchange Rates and Stabilization Policy, ed. by Jan Herin and others (Boulder, Colorado, 1977), pp. 195–207. This paper also appeared in Scandinavian Journal of Economics, Vol. 78 (1976).
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)| false Williamson, John, “Exchange-rate Flexibility and Reserves Use,”in Flexible Exchange Rates and Stabilization Policy, ed.by and Jan Herin others( Boulder, Colorado, 1977), pp. 195– 207. This paper also appeared in Scandinavian Journal of Economics, Vol. 78( 1976).
Mr. Quirk, Senior Economist in the Asian Department, is a graduate of the University of Canterbury, New Zealand.
An earlier version of this paper was presented at the meetings of the Western Economic Association held in Anaheim, California on June 20–23, 1977.
Bank of Japan, Economic Statistics Monthly.
See “Yen Is Not ‘Cheap,’” Oriental Economist, Vol. 44 (October 1976), p. 6. Although one may regard an increase in reserves that corresponds to transactions outside the foreign exchange market as nonintervention, it is more correct to regard the increase from an opportunity viewpoint—that is, as withholding exchange from the market.
∆FER ≃ ∆R − XM + ∆OD, where FEF is the net Foreign Exchange Fund position, R is gross official international reserves, XM represents the extra-market transactions, and OD is the outstanding level of official deposits with commercial banks. A positive sign denotes a net increase in assets.
Analysis of the respective contributions of capital controls and other factors to the determination of capital flows in the 1970s has been made more difficult by the transition to flexible exchange rates and by variations in the intensity with which controls have been implemented. For the results of estimation, using data for the period 1961–70, in which the onset or removal of capital restrictions is depicted by dummy variables, see Amano (1973).
As pointed out in Cooper (1977, p. 77), adoption of these strategies, described as “smoothing and braking,” implicitly acknowledges that “we do not know what the equilibrium exchange rate over any time period is, but it allows for the likelihood that the ‘market’ does not know either.”
See “Outline of Reform,” Annex 4, International Monetary Reform: Documents of the Committee of Twenty (Washington, 1974), pp. 33–37.
Guidelines (3)(a) and (3)(b) provide guidance in the situation where either the member or the International Monetary Fund, respectively, considers that adherence to Guidelines (1) and (2) would result in a departure of the exchange rate from “reasonable estimates of the medium-term norm.”
See Decision No. 5392–(77/63), International Monetary Fund, Annual Report of the Executive Directors for the Fiscal Year Ended April 30, 1977 (Washington, 1977), pp. 107–109.
Ibid., p. 132.
Ibid., pp. 131–32.
Leaning against the wind is given by It = a(St − St−1), while intervention consistent with gliding parities based on previous market rates is of the form
The latter two tests were also conducted in terms of the Japanese/industrial country export price relative, but these variables were even less significant.
Instances at which the exchange rate was at or near this floor were January 1974, August 1974, December 1974, December 1975, and, more approximately, November 1976.
The response estimated from equation (5), in which the acceleration of the exchange rate replaces market volume (the two variables are closely related and do not have separate significance), is virtually the same,
It = −64 + 99Ṡt + 54(Ṡt − Ṡt-1) + 0.595It-1
with the following long-run multipliers:
The asymptotic biases in coefficients estimated by single-equation methods in these circumstances are well known. See, for example, Malinvaud (1966), pp. 507–509.
The fact that exchange rate observations over very short time intervals follow a random walk does not preclude the existence of an observable relationship between the rate and its determinants. What it would suggest, however, is that the determinants are either numerous and diverse in their movements, possessing no systematic effect in sum, or, what is less likely, that the individual determinants are themselves nonsystematic. A study by Dooley and Shafer (1976) of exchange rate movements in major industrial countries concluded that the random walk hypothesis could not be rejected for daily observations of the yen rate (over the period March 1973–September 1975).
Although convergence may not be completed within the period of observation, the observed points are as likely to be displaced above as below the curve I. The stability of this process depends on the relative slopes of curves I and S. As long as the slope of I does not exceed that of S in absolute terms—that is, as long as the authorities do not consistently overreact—convergence toward equilibrium will occur.
S1, the exchange rate of country l’s currency, is expressed as units of the currency of country 2 (currency 2) per unit of its own currency (currency 1); an increase in S1 therefore denotes an appreciation of currency 1.
In equilibrium, which is not guaranteed in the short run, Ṡ = 0 and $S = $D, implying overall payments balance.
Another method of deriving an expression similar to equation (24) would be to state directly the condition for flow equilibrium in the balance of payments by setting the right-hand side of equation (23) equal to zero and to solve for the exchange rate.
Industrial output changes were used as a proxy for monthly income changes.
Several reasons may be advanced for the unexplained residual. First, the period reviewed is the first one of generalized floating and, while quite short, it has been characterized by large structural and cyclical shifts in the world economy. Second, the influence of restrictions on capital flows over this period has not proved amenable to modeling. Use of dummy variables has been precluded by the fact that not only the capital controls themselves have varied but their implementation has varied as well. However, there is evidence that the adjustment of controls to changing circumstances in the overall balance of payments takes place over a period considerably longer than one month. It is therefore unlikely that exclusion of this factor would result in substantial bias in estimations using monthly changes.
A similar equation, based on sensitivity of short-term capital stocks, rather than flows, to expected yield, in which the acceleration of the exchange rate is the dependent variable and Ṗ is replaced by P, attributed significance to the same independent variables.
The results were (using the Cochrane-Orcutt adjustment for serial correlation of errors):
where P is the ratio of the Japanese to the U. S. wholesale price index, PE is the ratio of the Japanese export price (expressed in dollars) to that of the industrial countries, S is the exchange rate, and T is a trend term.