THE ADVANTAGE TO HIDING ONES HAND - SPECULATION AND CENTRAL BANK INTERVENTION IN THE FOREIGN-EXCHANGE MARKET

We analyze an asymmetric information model of sterilized intervention in the foreign exchange market. We characterize an equilibrium in whic h a central bank with 'inside information' about its exchange rate tar get trades with risk averse speculators who have private information a bout future spot rates. The model identifies circumstances in which pe rverse' responses to intervention will be observed, i.e, the domestic currency depreciates when the central bank purchases it, and it provid es conditions under which the exchange rate will be highly sensitive t o intervention. The model also provides an explanation for two forms o f 'policy secrecy': (i) secrecy about the scale of an intervention ope ration is always desirable, (ii) secrecy about the target is sometimes desirable.