Case Study: Japanese Intervention in Foreign Exchange Markets
Foreign exchange intervention is defined generally as foreign exchange
transactions conducted by a country’s monetary authorities with the aim of
influencing exchange rates. In Japan, the Minister of Finance is legally
authorized to conduct intervention as a means to achieve foreign exchange rate
stability. The Bank of Japan, as the agent of the Minister of Finance, executes
foreign exchange intervention operations in accordance with the directions of the
Minister of Finance. Japan’s Foreign Exchange and Foreign Trade Law stipulates
that the Minister of Finance shall endeavor to stabilize the external value of the
yen by taking necessary measures including foreign exchange transactions.
Intervention by the Bank of Japan as the agent of the Minister of Finance is
conducted by the account of the Japanese Government, which is called the
Foreign Exchange Fund Special Account (FEFSA). This fund consists of foreign
currency funds and yen funds. In case of U.S. dollar buying/yen selling
intervention, for example, the yen funds to be sold are raised by issuing
Financing Bills. In the event of U.S. dollar selling/yen buying intervention, U.S.
dollar funds held in the FEFSA are used for buying the yen in the markets.
The Japanese Government holds large amounts of foreign currencies in the
FEFSA, partly as a result of foreign currency buying/yen selling interventions in
past yen appreciation phases. The Minister of Finance makes decisions on
investments of these currencies paying careful attention to liquidity and safety.
Most of these funds have been invested in securities issued by the authorities of
major industrial countries, which are almost immune from liquidity risk.
In the United States, the Treasury Department and Federal Reserve Board have
join authority for foreign exchange intervention; however, the Treasury
Department has priority with regard to the decision. Once the decision to
intervene is made, the policy is carried out by the Federal Reserve Bank of New
York.
There are cases where two or more monetary authorities implement intervention
jointly by using their own funds at the same time or in succession. This is called
"coordinated intervention."
Japan’s Post Bretton Woods Intervention
Since the demise of the Bretton Woods Exchange Rate System in the early
1970s, Japan has been one of the largest interveners in foreign exchange
markets. Between April 1991 and December 2000, for example, the Bank of
Japan bought U.S. dollars on 168 occasions for a cumulative amount of $304
billion and sold U.S. dollars on 33 occasions for a cumulative amount of $38
billion.
Japanese intervene overshadows all other countries' official intervention in the
foreign exchange market; exceeding U.S. intervention over the April 1991 to
December 2000 period by a factor of more than 30. It should be pointed out,
however, that the magnitudes of any central bank intervention, including those by
the Bank of Japan, are very small compared to overall market transactions in the
foreign exchange market.
Japanese intervention from 1991 through 2000 is charted in Figure 1.
As seen in the above chart, during this period, intervention can be divided into
three sub-periods: (1) 1991-1995, (2) 1997-98, (3) 1999-2000.
During sub-period 1 (1991-1995), Bank of Japan intervention generally involved
buying US dollars, especially from 1993 on. During the period from 1993 to mid
1995, the yen was a very strong currency against the US dollar (the yen reached
a post Bretton Woods high of 81.07 on April 19, 1995). In an attempt to offset, or
moderate, yen strength, the Bank of Japan intervened by buying dollars, the
weak currency (and selling yen, the strong currency). The chart below tracks the
exchange rate from January 1, 1993 through July 1995. In January 1993 the
exchange rate stood at 125 (in European terms) and by April 1995 the yen had
strengthened to just under 85.
During sub-period 2 (1997-98), Bank of Japan intervention involved selling US
dollars (buying yen). The amount of sales was especially large in late 1997/early
1998. As shown in the chart below, during this time the yen weakened against
the US dollar from a high of 115 in mid 1997 to a low of over 140 in July 1998.
During this time, the Bank of Japan was attempting to offset, or moderate, this
weak yen through the selling of dollars, the strong currency (and purchasing of
yen, the weak currency).
Finally, during the third sub-period, 1999-2000, Bank of Japan intervention
involved the buying of US dollars (selling yen). During this period, especially
from early 1999 to the end of that year, the yen was very strong against the US
dollar. In May 1999 to exchange rate stood at around 122 and by December
1999 the yen had strengthened to around 102. The buying of dollars, the weak
currency (and selling yen, the strong currency) in 1999 was an attempt to
counter, or moderate, the strengthening yen. The continued buying of dollars
into 2000 was a continuation of this policy.
Since March of 2004, the Bank of Japan has not intervened in foreign exchange
markets in support of the yen. During this period of time, especially from January
1, 2005 the yen has generally weakened against the US dollar.
Is Intervention Successful?
Since few studies have found evidence supporting a link between intervention
and exchange rates, many professional economists tend to be skeptical about
whether official intervention could (or should) play an important role as an
effective policy instrument to influence exchange rates. The most positive study
(Hutchison, 2003) suggested some success as measured in either slowing or
reversing the direction of exchange rate change out to periods of up to two
weeks. After that period of time, market fundamentals become dominate once
again.
The issue for central banks is really two fold. First, their intervention activities, by
their very nature, can only be small relative to the size of the foreign exchange
market itself. Second, given that any positive effects are short term, and then
market forces come to dominate, central bankers probably should consider very
carefully whether this use of their reserves is appropriate.
Central bankers in the developed world appear to have moved away, or are
moving away, from foreign exchange intervention. Before we give up on this
type of policy we should recognize that there might be situations associated with
unusual and extreme market aberrations where intervention might be justified for
very short term effects. Since this is a possibility, we should not rule out the use
of central bank interventions in the future.