Coordinated Currency Interventions Temporarily Move Exchange Rates

Summary of working paper 9648
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At least in the very short run, intervention policy is effective in moving the exchange rate, even when not accompanied by interest rate changes.

Japan's frequent (but previously secret) efforts to influence the value of the yen through aggressive purchases of U.S. dollars have been successful, especially when these market "interventions" involve more than $1 billion and are conducted in concert with the Federal Reserve System, according to a study by Rasmus Fatum and Michael Hutchison.

In Effectiveness of Official Daily Foreign Exchange Market Intervention Operations in Japan (NBER Working Paper No. 9648, commissioned for NBER's Japan Project), they show that Japan may be able to use currency market interventions as a tool to influence the value of the yen and, in turn, to stimulate economic activity.

As a policy alternative, that is significant, because the lever governments most often pull to affect currency values -- the one that allows them to raise or lower interest rates -- is not currently available to Japan. Japanese interest rates have been set at zero since 1995. This has seemingly left the country's government poorly positioned to perform the kind of currency value adjustments that could reverse the chronic deflation that has been a major component of Japan's seemingly intractable recession.

Fatum and Hutchison note that for many years Japan's Ministry of Finance, through its Bank of Japan (BoJ), has been the most aggressive government entity in the world when it comes to participation in foreign exchange markets. Yet there was no evidence that its interventionist proclivities actually yielded results. Economists, many of whom are skeptical that government currency purchases can substantially alter currency values, had been unable to study the effect of Japan's bold actions because the government did not officially report or discuss its activities in this area. That changed in 2001, when Japan began disclosing the date and amounts of its currency buying and selling.

The authors use this new information to study some 43 separate intervention "events" -- some of which took place over several days -- between 1991 and 2000. These were occasions in which Japanese officials, sometimes with the help of their American counterparts, attempted to influence the value of the yen. The authors were particularly interested in whether the intervention achieved the desired exchange rate changes even in the absence of the more tried and true tool: central bank-instigated interest rate adjustments. They find that, "at least in the very short run intervention policy is effective in moving the exchange rate," even when not accompanied by interest rate changes.

They observe that Japan's interventions were most effective when the BoJ joined forces with the Federal Reserve System to conduct currency transactions in excess of U.S. $1 billion. Of the 12 "large scale coordinated" interventions they study, 11 achieved the desired effect: they moved the yen either up or down in accordance with the policy goal of the moment.

"This result suggests that the Bank of Japan could indeed engineer exchange rate depreciation, thereby counteracting deflation and recession, even though interest rates cannot be moved further downward," the authors state. However, getting the United States to cooperate with Japan's currency purchases appears to be the key ingredient of success. Fatum and Hutchison note that Japan and the United States have not coordinated their efforts in this area since September of 1995. Since then, Japan's attempts at solo interventions have been successful only 60 percent of the time. "Under these circumstances it would appear that only persistent, large-scale and coordinated interventions (Bank of Japan and the Fed) would seem likely to effect a sustained movement in exchange rates," the authors conclude.

-- Matthew Davis