RESEARCH PAPER NO. 849

THE EFFECTIVENESS OF RESERVE BANK OF AUSTRALIA FOREIGN EXCHANGE INTERVENTION

BY

ZOE McLAREN

MAY 2002

Department of Economics. University of Melbourne. Melbourne Victoria 3010 Australia

Despite the absence of substantial evidence to support the claim that sterilised foreign exchange intervention does systematically affect exchange rates, Central Banks continue to employ this practice. Recent overseas studies strongly support the notion that intervention is effective in the short-term. This paper evaluates the effectiveness of foreign exchange intervention performed by the Reserve Bank of Australia and studies which factors enhance intervention, using an event-study methodology. The period considered includes 1991-1998. Evidence is found of the RBA being able to cause reversals in the exchange rate trend and effect the direction of the exchange rate. A number of factors were found to consistently contribute to successful intervention episodes. Intervention effectiveness was enhanced when the actual exchange rate was closer to its fundamental value and the absence of on-going intervention appeared to aid exchange rate smoothing. Evidence is also found in support of the hypothesis that the mechanism involved is that of signalling.