CENTRAL BANK INTERVENTION AND EXCHANGE-RATE VOLATILITY

This paper explores the effects of foreign exchange intervention by ce ntral banks on the behavior of exchange rates. The G-3 central banks h ave undertaken an unprecedented number of both coordinated and unilate ral intervention operations in the last 10 years. Existing empirical e vidence on the effectiveness of intervention is mixed: studies using d ata from the 1970s suggest that intervention operations that do not af fect the monetary base have, at most, a short-lived influence on excha nge rates, but more recent studies indicate that the intervention oper ations that followed the Plaza Agreement influenced both the level and variance of exchange rates. This paper examines the effects of US, Ge rman and Japanese monetary and intervention policies on dollar-mark an d dollar-yen exchange rate volatility over the 1977-1994 period. The r esults indicate that intervention operations generally increase exchan ge rate volatility. This is particularly true of secret interventions, which are those undertaken by central banks without notification of t he public. Overt interventions in the mid-1980s appear to have reduced exchange rate volatility, but in other periods, and for the 1977-1994 period as a whole, central bank intervention is associated with great er exchange rate volatility. (C) 1998 Elsevier Science Ltd. All rights reserved.