Effectiveness of Central Bank Intervention on the Foreign Exchange Market

In contrast to academic recommendations monetary authorities all over the world intervene on the foreign exchange market to actively manage the exchange rate. Particularly in the aftermath of the global financial crisis the exchange rate is abused by some countries in a “currency war” to artificially improve the own competitiveness and thereby harming trading partners. Aside from these heavily debated activities a number of open economies try to shield their currency from irrational exuberance of international investors and use interventions to maintain exchange rates around their fundamental levels. This study shows theoretically and empirically how intervention operations can be effective in the latter sense.