interventions are most effective. When there is high frequency of intervention the market has become too familiar and the impact is reduced.
Studies on the Japanese experience by Fatum and Hutchison, and Ito, revealed that intervention tends to be effective during a period of infrequent interventions (1999 to 2002) but ineffective (2003) or counterproductive during a period of very frequent interventions (first quarter 2004). An and Sun suggest that there is no uniform answer as to whether it is monetary policy or foreign exchange intervention which is more influential on exchange rates.
The importance of the policies on exchange rate fluctuations are country- specific; i.e., in some countries policy might effect the exchange rate to a similar degree as foreign exchange intervention while in other countries the impact of intervention might be much stronger. It is no great surprise therefore that Kim (2003) finds that foreign exchange interventions have a much greater impact on the exchange rate in the US as they do not target the exchange rate and interventions are infrequent.
Recessions and intervention – the case of the Swiss franc
Exchange rates become increasingly important in recessions as governments (in the absence of inflation constraints) look to combat deflationary pressures by promoting a weak currency. An insight to this thinking comes from the statement from Thomas Jordan, member of the Governing Board of the Swiss National Bank on 25 the September 2009:
The Swiss franc plays a key role in the development of the Swiss economy. Through the competitiveness of our export pricing, it impacts on our exports and consequently affects the business cycle. Via import prices, it has a direct impact on consumer prices. In addition, the Swiss franc has been – and still is – a factor in the success of the Swiss financial sector. The Swiss National Bank (SNB) takes the exchange rate into account in its monetary policy although it does not normally exert any direct influence on it. In the past, it has only been in rare emergency situations that the SNB intervened to directly influence exchange rate developments. However, from March 2009, the appreciation of the Swiss franc induced by safe haven effects, in an exceptionally difficult economic situation entailing deflation risks, prompted the SNB to prevent an appreciation of the Swiss franc against the euro by purchasing foreign currency.
For Switzerland, trade with the EU is very important to the economy. Exports to the EU as a percentage of total exports are 60%, while exports to the EU as a percentage of GDP are 23%. Therefore, the level of EUR/CHF is critical.
In 2009 and 2010 ongoing weakness of the euro and the reinstatement of the Swiss franc as a primary safe haven currency prompted action on a number of occasions. On 12 March 2009 the SNB bought at 1.4790 to move the price to 1.5340. This price movement can be seen in Figure 2.1.
Figure 2.1 – SNB buying CHF to move it from 1.4790 to 1.5340 against the euro
Source: Reuters
On 24 June 2009 the SNB bought and moved the CHF rate from 1.5020 to 1.5380 against the euro, which can be seen in Figure 2.2.
Figure 2.2 – SNB buys CHF to move it from 1.5020 to 1.5380 against the euro
Source: Reuters
It could be argued that the Swiss intervention was an outright failure. The authorities were forced to stand aside against the weight of Swiss franc buying and by August 2011 EUR/CHF had touched 1.05. In the same month the Swiss authorities adopted a zero interest rate policy to deter inflows.
Conclusion
This topic is very broad and while we can see that the role of intervention has generated a lot of debate and research amongst the academic community, the results are not clear cut. This, however, has not deterred a number of monetary authorities from intervening with some frequency. This has been particularly evident in Asia.
The importance to the market is that intervention does influence exchange rates and hedging policy. The difficulty for the market lies in determining the degree of impact and its sustainability.
Endnotes
3 IMF Board Decision No 5392-(77 63), adopted April 1977. [return to text]
4 G-5, 22 September 1985. [return to text]
5 G-7, 22 February 1987. [return to text]
6 Taylor, 2006. [return to text]
3. The Basics of Foreign Exchange
A definition of foreign exchange
All claims on foreign currency payable abroad, whether consisting of funds in foreign currency held with banks abroad, or bills or cheques, again in foreign currency and payable abroad, are foreign exchange (also called Forex or FX). In the trading of foreign exchange between banks only foreign currency held with banks abroad is concerned. For the purposes of this book foreign exchange only applies to bank balances denominated in foreign currency.
Foreign bank notes are not foreign exchange in this sense. They can be converted into foreign exchange provided they can be placed without restriction to the credit of an ordinary commercial account abroad. A currency, whether in foreign exchange or bank notes, is deemed convertible if the person holding it can convert (exchange) it freely into any other currency. Convertibility may be unrestricted or partial. Sterling, since 1979, is fully convertible whether the holder is resident in the UK or abroad, and regardless of whether it is a matter of current payments or financial transactions. Some countries recognise only external or non-resident convertibility.
Regulations may also draw a distinction, as far as convertibility is concerned, between funds arising from current transactions (goods and services) and those coming from purely financial operations. Exchange controls were common in the West until the 1980s. They now tend to be operated in emerging countries, especially in Asia and the Far East. It is important to ascertain prior to any transactions what conditions apply. It is usually easy to invest into a country but can prove extremely difficult to repatriate.
The foreign exchange market
The foreign exchange market is not a physical place. It operates on a global basis through a computer-linked group of banks whose function is to facilitate trading by providing buying and selling prices to the main participants (these are noted below). This is known as an over-the-counter (OTC) market. Banks are the intermediary between foreign exchange supply and demand. The interbank market is the wholesale market and this is where the banks trade with one another.
The development in communications and dealing technology has meant that there is a uniform price for a particular currency throughout the financial centres of the world. The main centres of trading are London and New York. Trading is continual from Sunday evening 20.00 GMT to Friday evening 22.00 GMT.
Historically, transactions would occur over the phone, telex or via brokers but now dealing platforms and electronic broking systems dominate, for example EBS. According to the BIS (Bank for International Settlements) Triennial central bank Survey 2010, the foreign exchange market turnover is about $4trn a day, which
