Sterilised central bank intervention in the foreign exchange market

We have studied the signalling role of sterilised foreign exchange interven tion using a market micro-structure framework. We have assumed that the mon etary authorities intervene in the foreign exchange market in order to targ et the value of a foreign currency. Since the fundamentals of the foreign c urrency are not necessarily equal to this objective, the central bank does not have an incentive to reveal its intervention operations and no announce ment on its activity will be credible. Under these circumstances, secret st erilised intervention can be used to influences agents' expectations and ex change rates, as the central bank possesses private information on these fu ndamentals. A surprising result of our analysis is that while announcements on the objective of intervention are not credible, they are not even desir able. In fact, the foreign exchange market is more efficient when this obje ctive is secret than when it is common knowledge, because in the former cas e the central bank is more aggressive and reveals more of its private infor mation. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classificat ion: D82; F31; G14; G15.