Is Official Exchange Rate Intervention Effective?

Abstract

I examine the effectiveness of exchange rate intervention within the context of a Markov‐switching model for the real exchange rate. The probability of switching between stable and unstable regimes depends nonlinearly upon the amount of intervention, the degree of misalignment and the duration of the regime. Applying this to dollar–mark data for the period 1985–98, I find that intervention increases the probability of stability when the rate is misaligned, and that its influence grows with the degree of misalignment. However, intervention within a small neighbourhood of equilibrium will result in a greater probability of instability.