BIS paper weighs effectiveness of FX intervention strategies

Research published yesterday by the Bank for International Settlements (BIS) finds no exchange rate intervention strategy dominates, as they each come with different costs and benefits.

In the working paper Foreign exchange intervention: strategies and effectiveness, authors Nuttathum Chutasripanich and James Yetman compare foreign exchange interventions to reduce volatility and to "lean against" large exchange rate movements. They test a model with three actors: 'fundamentalist' current account traders, speculative carry traders and central banks.

According to their model, reducing volatility comes with the side effect that speculation becomes less risky, thereby increasing speculation. Furthermore, central banks are unable to determine the fundamental value of exchange rates, making interventions "generally destabilising".

Leaning against FX movements avoids the problem of uncertain fundamentals, but "is no panacea", they write. It encourages speculation and works in the opposite direction to those market forces that are trying to return the exchange rate to its fundamental value.