Reverse-Entrustment Intervention

Similarly, when foreign monetary authorities need to intervene in a country's foreign exchange market, say Tokyo market, the central bank of Japan can conduct interventions on their behalf upon request. This is called "Reverse-Entrustment Intervention".

Concerted or Coordinated Intervention

There are cases where two or more monetary authorities implement intervention jointly by using their own funds at the same time or in succession. This is called "Concerted or Coordinated Intervention."

Sterilization and Non-sterilization

Studies of foreign exchange intervention generally distinguish between intervention that does or does not change the monetary base. The former type is called non-sterilized intervention while the latter is referred to as sterilized intervention. Central banks sometimes carry out equal foreign and domestic assets transaction in opposite directions to nullify the impact of their foreign exchange operations on the domestic money supply. When a monetary authority buys (sells) foreign exchange, its own monetary base increases (decreases) by the amount of the purchase (sale). In order to prevent the money stock from increasing (decreasing), the monetary authorities can sterilize the effect of the exchange market intervention by selling (buying) short-term domestic assets to (from) the banking system leaving the monetary base of the country unchanged. Since sterilized intervention does not affect the money supply, it does not affect prices or interest rate and so does not influence the exchange rate. Rather, sterilized intervention might affect the foreign exchange market through two routes: the portfolio-balance channel and the signaling channel.

According to the portfolio-balance channel, it is assumed that risk-averse wealth holders diversify their portfolio across assets denominated in different currencies. Let's use the United States and Japan as an example. The portfolio balance channel theory holds that sterilized purchases of yen raise the dollar price of yen because investors must be compensated with a higher expected return to hold the relatively more numerous U.S. bonds. To produce a higher expected return, the yen price of the U.S. bonds must fall immediately. That is, the dollar price of yen must rise.

In contrast, the signaling channel assumes that intervention affects exchange rates by providing the market with new relevant information, under an implicit assumption that the authorities have superior information to other market participants. The authorities are willing to reveal this information through their actions in the foreign exchange market. Because private agents may change their exchange rate expectation after intervention, the exchange rate then will be expected to change immediately after the effect occurs.

Indirect Intervention

Recall that while official intervention is generally defined as foreign exchange transactions of monetary authorities designed to influence exchange rates, it can also refer to other (indirect) policies for that purpose. There are innumerable methods of indirectly influencing the exchange. These methods involve capital controls (taxes or restrictions on international transactions in assets like stocks or bonds) or exchange controls (the restriction of trade in currencies).

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EFFECTIVENESS OF CENTRAL BANK INTERVENTION

Most of the interventions were aiming at stabilizing the disorderly exchange rate market; unfortunately, many studies revealed that intervention could not smooth the exchange rate movement.

Intervention may Decrease Volatility

Central bank intervention may reduce exchange rate volatility if it resolves uncertainty by market participants about future monetary policy. For example, if the market is uncertain about the stance of monetary policy, then intervention to halt a drop in the dollar may signal that the Federal Reserve is committed to a tight monetary policy. The resolution of uncertainty about future monetary policy may then lead to less exchange rate volatility.

Central bank intervention may also reduce exchange rate volatility by reducing the likelihood of a speculative bandwagon. Suppose the dollar exchange rate falls from
120$ to 115$. As speculators see the dollar falling, they may jump on the bandwagon thinking the dollar may fall further to 110$. Under this scenario, speculators who sell $1 million at 115$ could make a profit if the dollar falls to
110$ and they reacquired dollars at the lower value. However, if the central bank intervenes at 115$ and pushes the dollar back to 120$, then speculators could suffer a loss. Speculators may therefore become reluctant to push the dollar down too rapidly if they believe the central bank will intervene to prevent the dollar from falling. By reducing selling pressure when the dollar starts to fall, central bank intervention could reduce speculative bandwagons and thereby reduce volatility.