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Market Volatility and Foreign Exchange Intervention in EMEs

As the economic crisis has exacerbated volatility in the foreign exchange markets of emerging market economies (EMEs), many central banks have been forced to intervene. Although the majority view is that the purpose of forex intervention is to reduce volatility, some central banks have opted to intervene through the use of currency-options-based trading strategies. The benefits of such interventions are largely dependent on their effectiveness in anchoring market expectations and reducing excessive volatility.

Global financial system

This paper documents the diverse types of foreign exchange intervention (FXI) that central banks conduct in the global financial system under various policy objectives. While most central banks exercise discretion in foreign exchange market interventions, some have opted to use publicly declared rules to strengthen the signaling channel of their policies. In the case of emerging market economies, FXI is often conducted under a rule that explicitly stipulates the time-frame and extent of interventions. This approach results in lower volatility of foreign exchange reserves in EMEs.

Policymakers

he authors of this volume summarize the discussion of the Deputy Governors of major EMEs at their meeting in Basel on 21-22 February 2013. They address three main questions: how much intervention is effective, whether interventions can be measured, and are they necessary. This paper will help policymakers better understand the motivations behind the intervention and how to measure its effectiveness. A flexible exchange rate promotes financial development and preserves financial stability.

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