Foreign Exchange Intervention in Two Small Open Economies: The Canadian and Australian Evidence

Abstract

We examine intervention by the Bank of Canada and the Reserve Bank of Australia for daily data from 1989 to 1998. Both central banks used to intervene in response to exchange rate volatility and uncertainty that appeared excessive. Volatility is measured via the implied volatility of foreign currency futures options. Uncertainty is proxied by the kurtosis of the implied risk-neutral probability density functions. We also examine the impact from the introduction of inflation targeting. In a departure from other studies of this kind, we explicitly consider the role of commodity futures prices. After all, both countries have been seen by many traders as being commodity currencies. Moreover, we also take into account the impact of a wide range of news events on the intervention practices of both central banks. These additional variables turn out to help explain the effectiveness of intervention. Central bank intervention was largely unsuccessful in both countries though volatility and kurtosis were modestly affected. We also find some notable differences in the impact of inflation targets in both countries on the effectiveness of foreign exchange intervention.

JEL Classification: F31