Exchange Rate Management in Interdependent Economies: From Williamsburg to Louvre (Schriftenreihe Handeln Und Entscheiden in Komplexen Okonomis)

With the breakdown of the Bretton Woods System and the begin of floating between the major currencies, central banks have been formally freed from their obligations to defend the fixed parities of bilateral exchange rates. Nev­ ertheless, since then there have been countless occasions on which monetary authorities have officially intervened in the foreign exchange market. More­ over, numerous studies indicate that exchange rates have been much more variable than originally anticipated - in real and in nominal, as well as in short run and longer run measures (see for example Hesse and Braasch [1989] and Marston [1988]). Through the experience of high real sector costs, the topic of optimal exchange rate management soon reentered policy discussions. The term exchange rate management encompasses both the choice of ex­ change rate regime as well as active intervention policies within the given 1 system. Much of the recent policy discussion has focussed on the first issue, in particular proposals of how to reform the present international monetary order. And new systems such as the European Monetary System (EMS) have emerged for subgroups of countries. However, the question of finding the optimal system has not yet been resolved. The theoretical part of this book analyzes non-cooperative and cooperative policies of exchange rate management within a formal two-country game-theoretic framework where interventions are fully neutralized and signal future changes in monetary policy. This analysis incorporates two novel factors crucial for understanding real-world intervention experience; partial credibility and non-rational expectations. In contrast to traditional models of the repeated games literature where reputational effects establish full credibility, in the theory presented here centralbank credibility problems (towards the private sector and other countries) cannot be eliminated. While this reduces the effectiveness of central bank signals, this also motivates the use of costly interventions as opposed to mere policy announcements. Secondly, the introduction of non-rational expectations allows to account for the differing successes of actual centralbank intervention operations. The empirical part investigates whether Bundesbank interventions in the US dollar market between 1983-87actually served as signals of future changes in the monetary base. By using several alternative models of expectation formation the study cannot uncoverany favorable evidence for this hypothesis. Strikingly, this result emerges for both unilateral and coordinated intervention policies Front Matter....Pages i-xviii Introduction....Pages 1-12 Front Matter....Pages 13-13 Effectiveness of Foreign Exchange Market Interventions....Pages 15-23 A Signalling Model of Interventions....Pages 25-55 Back Matter....Pages 57-58 Front Matter....Pages 59-59 Non-Cooperative Intervention Policies....Pages 61-78 International Central Bank Cooperation....Pages 79-97 The International Prisoner’s Dilemma....Pages 99-111 Back Matter....Pages 113-114 Front Matter....Pages 115-118 Did Bundesbank Interventions serve as Signals of Monetary Policy?....Pages 119-139 Back Matter....Pages 141-141 Back Matter....Pages 143-172