PDF《The Practice of Central》

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1 Empirically, it has been very difficult to establish the reaction of exchange rates to changes in economic fundamentals.

2 MAY/JUNE

2001 R E V I E W balance channel theory holds that sterilized pur- chases of yen raise the dollar price of yen because investors must be compensated with a higher ex- pected return to hold the relatively more numerous U.S. bonds. To produce a higher expected return, the yen price of the U.S. bonds must fall immedi- ately. That is, the dollar price of yen must rise. In contrast, the signaling channel theory assumes that official intervention communicates informa- tion about future monetary policy or the long-run equilibrium value of the exchange rate. Spot and Forward Markets for Intervention The previous example implicitly assumed that the Federal Reserve Bank of New York conducted its purchase of yen in the spot market―the mar- ket for delivery in two days or less. Intervention need not be carried out in the spot market, how- ever;

it also may be carried out in the forward market.2 Forward markets are those in which currencies are sold for delivery in more than two days. Because the forward price is linked to the spot price through covered interest parity, inter- vention in the forward market can influence the spot exchange rate. To understand covered interest parity, con- sider the options open to an American bank that has capital to be invested for one year. The bank could lend that money at the interest rate on U.S. dollar assets, earning the gross return of (1+it USD) on each dollar. Or, it could convert its funds to a foreign currency (e.g., the euro), lend that sum in the overnight euro money market at the euro interest rate, and then convert the proceeds back to dollars at the end of the year. If, at the begin- ning of the contract, the bank contracts to convert the euro proceeds back to dollars, it will receive 1/Ft,t+365 dollars for each euro, where Ft,t+365 is the euros-per-dollar forward exchange rate. The gross return to each dollar through this second strategy is , where St is the euros-per-dollar spot exchange rate on day t. If the return to one strategy is higher than the other, market participants will invest in that strategy, driving its return down and the other return up until the strategies have approximately S F i t t t t euro , + + ( )

365 1 equal return. Covered interest parity (CIP) is the condition that the strategies have equal return: (1) As equation (1) must approximately hold all the time, intervention that changes the forward exchange rate must also change the spot exchange rate.3 For example, a forward purchase of euros that raises Ft,t+365 must also raise St. Forward market interventions―the purchase or sale of foreign exchange for delivery at a future date―have the advantage that they do not require immediate cash outlay. If a central bank expects that the need for intervention will be short-lived and will be reversed, then a forward market inter- vention may be conducted discreetly, with no effect on foreign exchange reserves data. For ex- ample, published reports indicate that the Bank of Thailand used forward market purchases to shore up the baht in the spring of

1997 (Moreno, 1997).4 Both the spot and forward markets may be used simultaneously. A transaction in which a currency is bought in the spot market and simul- taneously sold in the forward market is known as a currency swap. While a swap itself will have li........