The effects of central bank intervention in Korea: By exchange rate system and monetary credibility
Economic theory suggests that the sterilized intervention could successfully manipulate the exchange rate through two channels: Portfolio-balance channel and Signaling channel. I, however, argue that the effectiveness of central bank's intervention is less certain for influencing the exchange rate and ask under which conditions the intervention is most effective. In particular, does the credibility of the central bank increase the intervention effect?; I focus on the two policy perspectives in Korea: the exchange rate policy and the monetary policy. I have a posit that a transition of the exchange rate system from 'dual basket system' to 'market average exchange rate system' and a widening of band widths increase the credibility because they curtail the exchange rate control and give the monetary authority an inflation fighting reputation. I also assume that a central bank's effort to keep the actual money growth rate within the target range and a stable money supply policy increase the credibility since it provides the public with less money expectational error. From the empirical tests using VAR model over the sample period from 1987 through 1994, I find that the Bank of Korea leans against the wind. Also, the sensitivity of the intervention is stronger in Won-appreciating periods, reflecting that the Bank of Korea has attempted to promote exports as well as to fight inflation. Then, I find that the empirical evidence supports our hypothesis that the effect of intervention on the exchange rate is more effective under the market average exchange rate system, when central bank credibility is higher. Moreover, I find that the effect of intervention with respect to the different band widths is partly supportive of our hypothesis. Next, I find that the money supply is positively related to the intervention, implying that the signaling channel could be effective. The empirical tests to investigate the intervention effect with respect to the credibility of monetary policy, however, are inconclusive. The news about monetary expansion and monetary contraction have only temporary effects on the exchange rate, though the impulse responses show significant and correct signs when the central bank is viewed as credible.