Forward exchange market intervention under fixed exchange rates

Abstract

Forward exchange market intervention is a policy instrument which has been used mainly during the turbulent final years of the Gold Standard and the Bretton Woods system. It seems to be capable of counteracting temporary disturbances to the balance of payments as a substitute for monetary and exchange rate policy, but it has failed to offset more fundamental disequilibria. It is still relevant in countries which fulfill its basic requirements - deviations from uncovered and covered interest parities. The paper shows how forward exchange market intervention fits into a static portfolio model based on mean-variance optimization and how it is related to the famous Modern Theory of Forward Exchange. Forward intervention can work as a substitute for monetary policy in the case of temporary disturbances when effects on total wealth and the real sector can be ignored. However, the role of forward intervention reduces to a complementary one in the case of more fundamental trade balance disequilibria.