The Advantage of Hiding Both Hands: Foreign Exchange Intervention, Ambiguity and Private Information

S.C.W. Eijffinger, W.H. Verhagen

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Abstract

This paper analyzes a dynamic exchange rate policy game in which the central bank has private information about its short-term exchange rate target, on the one hand, and in which the market is faced with a certain degree of ambiguity concerning the actual intervention volume, on the other. Sterilized interventions are shown to derive their effectiveness from the fact that they transmit information about the short-term exchange rate target to the market. In this respect, we provide an explanation for the presumed inconsistency between intervention secrecy and the effectiveness of the signalling channel since our model predicts that interventions will be more effective on average if the central bank retains some degree of ambiguity. Moreover, it is also shown that sterilized interventions will not exert a lasting effect on the exchange rate. Finally, we have also investigated the extent to which some political and economic parameters determine the size of the intervention bias.
Original languageEnglish
Place of PublicationTilburg
PublisherMacroeconomics
Number of pages37
Volume1997-30
Publication statusPublished - 1997

Publication series

NameCentER Discussion Paper
Volume1997-30

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