Targeting Exchange Rates: Theory and Evidence from the Recent Managed Float

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Governments frequently target macroeconomic variables such as exchange rates and interest rates through a mixed policy of occasional interventions affecting floating rates. Under the recent managed float, for example, monetary authorities allow exchange rates to be determined by market forces most the time, only to intervene as rates deviate significantly from target levels. Accordingly, it has been frequently reported in the financial press that occasional government intervention appears to influence expectations on the part of private market traders who face possible capital gains and loses from these events. If this is the case, asset prices should reflect expected interventions to target rates. The purpose of this project is to develop a model for analyzing the effects of government interventions that prevent movements in interest and exchange rates from targeted levels. The analysis will show how the perceived threat of occasional capital gains or losses induced by central bank interventions may influence market trading. The model will also be used to empirically evaluate the behavior of exchange rates when intervention policies are used to target rates. This research is important because it will help us better understand how policies of targeting exchange rates affect the market's perception of these policies and how these perceptions, in turn, affect rates.