RBI's intervention in foreign exchange market - An econometric analysis

In the aftermath of the currency crises around the world the role of the ce ntral banks' interventions in the foreign exchange market has gained in imp ortance. It is obvious that such intervention affects the exchange rate in two ways, first, by affecting the extent of excess demand in the foreign ex change market, and thereafter through a complex interplay of the macroecono mic variables. The stylised literature has addressed this issue by estimati ng the so-called offset coefficients, a method that is ad hoc and that is m arked by the conspicuous absence of an underlying macro-model. In this pape r, we build on the stylised Mundell-Fleming model, and derive an estimable reduced form expression that allows us to link exchange rate movements with the RBI's interventions. The model itself and the subsequent empirical res ult indicate that the effect of RBI's intervention in the foreign exchange market is at best unclear. Specifically, given the time span of the data, t he RBI's interventions in the market seem to have been ineffective.