Central Banks in Developing Countries Can Influence

¶ … central banks in developing countries can influence their position on the exchange market through exchange rate interventions. The current exchange rate mechanics are based on a floating exchange rate that is valued based on the market conditions. Any intervention by a central bank should be short lived because the market equilibrium will return to the value of the expectations for the currency that were set in the market. However, many argue that the exchange rate interventions can represent a powerful policy tool for emerging market economies (EMEs).

Since the financial crisis of 2008, there has been a substantial higher volatility in the flow of capital. As a result many of the central banks in EMEs have intervened on a regular basis for the purpose of trying to manage their exchange rate on the global market. The argument is that economic agents, rather than rational expectations, can serve as the primary driver for exchange rate expectations. There is some evidence that central banks can be effective on spot exchange rates.

Furthermore there have some studies to suggest that the central banks can actually communicate their intentions in the intervention to further guide the markets and the perceptions of the investors for the purpose of further guiding markets. The researchers in the study developed a theoretical model to help understand the association between factors such as interest rate differentials, perceived risk, and domestic interest rates (Miyajima, 2013). Data was collected from countries with floating exchanges in Asia and Latin American.

Countries were collected that different degrees of capital openness such as Brazil, Peru, Korea, and Malaysia. Within the selected countries, data was collected from 2004 to 2012; however data was excluded from July 2008 to March 2009 because of the influence of Lehman's bankruptcy on capital markets. One of the challenges of the study was to measure the level of foreign exchange rate intervention. They simplified this process by using aggregate data that was available on different instruments and assumed their impact on the exchange rate was roughly similar.

There were a number of other factors that were included as key variables in the regression analysis. The study found that central bank intervention does not seem to systematically influence near-term exchange rate expectations in the direction desired by the central bank. Furthermore, central bank foreign exchange rate intervention may have had unintended effects in the countries studied. One interpretation of the result is that the intervention does not change the near-term exchange rate expectations.

Another perspective could be that dollar purchases by central banks can attract more foreign inflows and lead to expectations of stronger EM exchange rates. Discussion The purpose of the study was to basically evaluate the market intervention power of EMEs central banks to manipulate exchange rates in the short-term. If exchange rate markets are perfectly efficient, then the central bank should have little to no effect in the short run or the long run.

Any intervention to influence the exchange rate directly would immediately be washed out in a new market equilibrium that would account for these variables. The net effect of the intervention would therefore be a wash. On the other hand, if the markets are not completely efficient, then there is the possibility that the central banks could alter the investors perceptions about the speculative activity associated with the inflow or outflow of capital.

If speculation is a real force in the foreign exchange rate markets, then the news of the central bank taking action in one effort or another could impact the exchange rate in a tangible manner. Furthermore, there are varying degrees that are possible if the market allows for some level of inefficiency that is based on speculation, for example.

Although this study tries to isolate all the variables that could contribute their influences to the exchange rate, in reality the market is incredibly complex and therefore cannot possibly account for all of the influences that are found in reality. Although the study does account for interest rate expectations, international country risk premiums, international energy prices, foreign capital inflows, growth expectations, and U.S. data surprises, many of these variables have some level of inherent biasness and subjective interpretations.

It is likely that subsequent studies done with different data sets could potentially produce different outcomes. Other studies, such as this study indicates, have findings that suggest that.