RDP 2003-04: Identifying the Efficacy of Central Bank Interventions: Evidence from Australia 6. Conclusion

The endogeneity of exchange rates and intervention has long plagued studies of the effectiveness of central banks' actions in foreign exchange markets. Researchers have either excluded contemporaneous intervention, so that their explanators are predetermined, or obtained a small, and typically incorrectly signed, coefficient on contemporaneous intervention. Failing to account for the endogeneity, when central banks lean against the wind and trade strategically, will likely result in a large downward bias to the coefficient on contemporaneous intervention – explaining the negative coefficient frequently obtained.

This paper uses a novel identification assumption, a change in RBA intervention policy, that allows us to estimate a model that includes the contemporaneous impact of intervention. We use simulated GMM to estimate the model. There are three main results. Our point estimates suggest that central bank intervention has a substantial effect. We find that a (sterilised) purchase of US$100 million of Australian dollars by the RBA would be associated with an appreciation of between 1.3 and 1.8 per cent. These estimates are remarkably similar to that in Dominguez and Frankel (1993c), even though our estimation methodology is completely different, depending on only exchange rate and intervention data. Second, an intervention is shown to have its largest effect on the exchange rate on the day in which it is conducted, with smaller effects on subsequent days. This finding has not previously been demonstrated in the literature due to the problem of endogeneity, and confirms the beliefs of central banks of the immediacy of the effects of intervention. Finally, we confirm findings that Australian central bank intervention policy can be characterised as leaning against the wind.