Motivations for Foreign Exchange Intervention in Developed and Underdeveloped Capital Markets: Empirical Evidence from Croatia and Japan

Gunther Schnabl

Applied Economics Quarterly (formerly: Konjunkturpolitik), 2011, vol. 57, issue 1, 45-65

Abstract: The target zone model by Krugman (1991) assumes that foreign exchange intervention targets exchange rate levels. It is argued that the fit of this model depends inter alia on the stage of development of capital markets. Foreign exchange intervention of countries with highly developed capital markets is in line with Krugman's (1991) model as the exchange rate level is targeted (mostly to sustain the competitiveness of exports) and the volatility of day-to-day exchange rate changes is left to market forces. In contrast, countries with underdeveloped capital markets control both volatility of day-to-day exchange rate changes as well as long-term fluctuations of the exchange rate levels to sustain the competitiveness of exports as well as to reduce the risk for short-term and long-term payment flows. Estimations of foreign exchange intervention reaction functions for Japan and Croatia trace the asymmetric pattern of foreign exchange intervention in countries with developed and underdeveloped capital markets.

Keywords: foreign exchange intervention; target zones; underdeveloped capital markets; reactions functions (search for similar items in EconPapers)
JEL-codes: F31 (search for similar items in EconPapers)
Date: 2011
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