The Effectiveness of Foreign-Exchange Intervention: Recent Experience

Since the September 1985 Plaza Hotel announcement by the Group of Five industrial countries, a substantial realignment of exchange rates has been achieved. At the same time, foreign exchange market intervention, much of it concerted and much of it sterilized, has been undertaken on a scale not seen since the early 1970s This paper takes a fresh look at the effectiveness of sterilized intervention in the light of recent experience. The paper concludes that sterilized intervention, in itself, has played an unimportant role in promoting exchange-rate realignment. Instead, clear shifts in patterns of monetary and fiscal policy appear to have been the main medium-term policy factors determining currency values. Over certain shorter time periods, intervention has influenced exchange markets through a signalling channel; but this signalling effect has been operative only as a result of authorities' frequent readiness to adjust monetary policies promptly to counteract unwelcome exchange-market pressures. The paper makes some progress in formalizing reasons why intervention might enhance the credibility of messages that governments could convey as well through simple verbal announcements.