The Forward Exchange Market, Speculation, and Exchange Market Intervention

35 Pages Posted: 15 Jul 2004 Last revised: 13 Aug 2010

See all articles by Jonathan Eaton

Jonathan Eaton

Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Stephen J. Turnovsky

University of Washington - Institute for Economic Research; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: June 1983

Abstract

This paper develops a stochastic equilibrium model of an open economy incorporating speculation in the forward exchange market. The model is used to examine two issues. The first is the role of speculation in stabilizing the economy against stochastic disturbances. Much risk averse speculation stabilizes domestic income against disturbances in the domestic bond market and forward exchange marketbut exacerbates the effect of foreign disturbances. Speculation may dampen or augment the effect of money market and output supply disturbances depending upon the share of foreign bonds in total wealthand the interest elasticity of bond demand. The second issue that the model addresses is the role of the forward market in stabilization policy. Forward market intervention (or its equivalent in this model,sterilized spot market intervention) does not provide monetary authorities additional leverage in stabilizing income beyond unsterilized spot market intervention. Intervention rules based on reactions to both the forward and the spot exchange rates, however, can outper-form intervention policies responding to the spot rate alone,regardless of the market in which intervention occurs.

Suggested Citation

Eaton, Jonathan and Turnovsky, Stephen J., The Forward Exchange Market, Speculation, and Exchange Market Intervention (June 1983). NBER Working Paper No. w1138. Available at SSRN: https://ssrn.com/abstract=305525

Jonathan Eaton (Contact Author)

Leonard N. Stern School of Business - Department of Economics ( email )

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HOME PAGE: http://www.econ.nyu.edu/user/eatonj/

National Bureau of Economic Research (NBER)

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Stephen J. Turnovsky

University of Washington - Institute for Economic Research ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

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