Exchange rate volatility and optimal central bank intervention

Hui-Kuan Tseng ()
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Hui-Kuan Tseng: The University of North Carolina at Charlotte, Department of Economics, Postal: 9201 University City Blvd, Charlotte, NC 28223-0001, http://www.uncc.edu/

Economia Internazionale / International Economics, 2008, vol. 61, issue 4, 729-754

Abstract: This research re-examines the desirability of central bank interventions in foreign exchange to reduce spot exchange rate volatility. A small open-economy macroeconomic model is developed to incorporate both macroeconomic fundamentals and micro-structural features of foreign exchange markets. The research derives the optimal central bank intervention based on the fundamental exchange rate, the target exchange rate and the last-period exchange rate. Numerical simulations suggest that central bank interventions tend to dampen spot exchange rate volatility, regardless of the source of disturbances. However, in most cases, central bank interventions only have rather modest effects. Further, the desirability of central bank intervention is generally insensitive to the degrees of price flexibility, capital mobility, speculation, and central bank’s commitment to its target exchange rate.

Keywords: Macro Fundamentals; Central Bank Intervention; Speculation; Exchange Rate Volatility (search for similar items in EconPapers)
JEL-codes: E58 F31 G15 G18 (search for similar items in EconPapers)
Date: 2008
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