How are Exchange Rates Managed? Evidence of Error-Correction Around a Reference
20 Pages Posted: 13 May 2012 Last revised: 14 May 2012
Date Written: March 7, 2012
In managed floats, central banks often intervene in the foreign exchange market to obtain politically desirable exchange rates. How this is done has remained totally opaque although central banks are likely to adopt a satisfying rather than optimizing strategy since they need to intervene frequently in a timely manner under incomplete information. In this paper, we propose a simple exchange rate management rule that balances the amount of variation between currency pairs around a reference rate. We test out this rule using the Chinese Yuan as a case study before extending the study to 9 other currencies. Empirical results are consistent with the hypothesis that central banks follow the error correction rule in exchange rate management.
Keywords: Exchange rate policy, Managed float, Error correction model
JEL Classification: F31, O24, P21
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