Is Sterilized Foreign Exchange Intervention Effective after All? An Event Study Approach

Abstract

Central banks actively engage in sterilized foreign exchange market intervention despite numerous empirical studies indicating that these operations do not systematically affect the exchange rate. Are these policies misguided and central bankers irrational? Or is evidence showing the effectiveness of sterilized intervention being overlooked? This paper argues the latter, providing evidence on the effectiveness of sterilized intervention using an event study approach linking intervention with systematic exchange rate changes. Studies using time-series techniques are limited by the nature of the data: intense and sporadic bursts of intervention activity juxtaposed against exchange rates that change almost continuously on a daily basis. The event study framework used in standard finance studies, by contrast, is better suited to this circumstance. Focusing on daily Bundesbank and US official intervention operations, we identify separate intervention "episodes" and analyze the subsequent effect on the exchange rate. Using the nonparametric sign test and matched-sample test, we find strong evidence that sterilized intervention systemically affects the exchange rate in the short-run. This result is robust to changes in event window definitions over the short-run and to controlling for central bank interest rate changes during events.