## Does Foreign Exchange Intervention Slow the Pace of Currency Appreciation?

_IMF Blog, May 4, 2011_

## Source details

**Canonical URL:** [Does Foreign Exchange Intervention Slow the Pace of Currency Appreciation?](https://www.imf.org/en/blogs/articles/2011/05/04/foreign-exchange-intervention-in-latin-america)

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## Bibliographic details
- Authors: Gustavo Adler, Camilo E Tovar
- Published: May 4, 2011

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### Overview
- Abundant global liquidity and high exposure to capital movements have put foreign exchange intervention at center stage of the policy debate in Latin America.
- The analysis covers intervention practices and effectiveness for a group of economies in Latin America and other regions during 2004-10.
- Key questions examined:
  - How do Latin American countries intervene and in what respects do they differ from other economies?
  - What are the rationales for these policies?
  - How effective have they been in affecting the exchange rate?
- Most central banks in Latin America were actively involved in foreign exchange markets and, on average, about one third intervened on any given day.
- Intervention in the region came in waves—frequently corresponding with shifts in global financial conditions—and there are cross-country differences:
  - Chile, Colombia, Guatemala, and Mexico were moderate interveners.
  - Peru and Uruguay (dollarized economies) and Brazil intervened more heavily.
- Intervention has often been accompanied by exchange rate appreciation, complicating causal assessment because:
  - Intervention affects the exchange rate.
  - The decision to intervene depends on the exchange rate.
  - The counterfactual (what would have happened absent intervention) is unknown.

### How countries intervene
- Information gaps exist on central bank intervention practices; a qualitative database was developed using central bank publications, statements, and press releases to fill some gaps.
- Most common stated rationales:
  - To build international reserve buffers.
  - To contain exchange rate volatility.
  - Other stated reasons tend to be vague.
- Rule-based versus discretionary approaches:
  - Central banks in one third of the countries looked at have used some form of rule-based approach to intervention.
  - Rule-based approaches are more common in Latin America, with country variation:
    - Chile and Mexico always used rules when intervening.
    - Colombia and Guatemala relied on rules while giving themselves room for discretionary purchases.
    - Brazil, Peru, and Uruguay did not use rules.
- Market instruments used:
  - The spot market is the most commonly used market, possibly reflecting higher liquidity.
  - As derivative markets expanded, some central banks increased use of such instruments:
    - Central Bank of Brazil uses forward and swap markets.
    - Central Banks of Colombia and Mexico have used options.
- Transparency:
  - Latin America is among the most transparent regions in terms of its operations, publishing better and more timely information.

### How effective is intervention?
- No immediate impact of interventions on the rate of appreciation was detected.
- Statistically significant effects were found on the pace of appreciation:
  - Increasing interventions by 0.1 percent of GDP will produce—in one week and in comparison to a country that does not intervene—a 0.3 percent slowdown in the pace of appreciation.
- Effectiveness by institutional/design features:
  - Effectiveness is not dependent on the use of rules or discretionary frameworks, or on the degree of transparency.
  - Greater financial integration may significantly reduce the effectiveness of interventions.
  - Intervention is more effective in Asia than in Latin America, consistent with regional differences in financial integration.
- Timing and misalignment:
  - Interventions are most effective when there are signs of the currency being overvalued compared to its recent history.
  - This highlights the importance of intervening “when the time is right,” and never “too early”.

### Conclusions and policy implications
- Foreign exchange market interventions may help to mitigate appreciation temporarily.
- The impact of intervention depends on country-specific circumstances and characteristics.
- Key factors influencing effectiveness:
  - Degree of capital account openness.
  - Exchange rate misalignment.
- Policymakers should weigh benefits against costs:
  - Foreign exchange intervention carries major quasi-fiscal costs and other nonfinancial costs.

*Source: Does Foreign Exchange Intervention Slow the Pace of Currency Appreciation? (Gustavo Adler, Camilo E. Tovar, May 4, 2011)*

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## References

- [Regional Economic Outlook: Western Hemisphere](http://www.imf.org/external/pubs/ft/reo/2011/whd/eng/wreo0411.htm)
- [https://www.imf.org/wp-content/uploads/2011/05/whd-reo-intervention2.jpg](https://www.imf.org/wp-content/uploads/2011/05/whd-reo-intervention2.jpg)
- [https://www.imf.org/wp-content/uploads/2011/05/whd-reo-intervention1.jpg](https://www.imf.org/wp-content/uploads/2011/05/whd-reo-intervention1.jpg)

_Source: https://www.imf.org/en/blogs/articles/2011/05/04/foreign-exchange-intervention-in-latin-america_