DP3758 Is Official Exchange Rate Intervention Effective?

Author(s): Mark P Taylor

Publication Date: February 2003

Keyword(s): real exchange rate , official intervention , non-linearity , mean reversion

JEL(s): C10 , F31 , F41

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP3758.asp

I examine the effectiveness of exchange rate intervention within the context of a Markov-switching model for the real exchange rate. The probability of switching between stable and unstable regimes depends non-linearly upon the amount of intervention, the degree of misalignment and the duration of the regime. Applying this to dollar-mark data for the period 1985-98, I find that intervention increases the probability of stability when the rate is misaligned, and that its influence grows with the degree of misalignment. Intervention within a small neighbourhood of equilibrium will result in a greater probability of instability.