Official Intervention in the Foreign Exchange Market, or, Bet Against the Central Bank

Abstract

Evaluating official foreign exchange intervention during the 1970s using Friedman's profit criterion shows that central banks have failed to stabilize the exchange markets and have lost billions of dollars. The monetary authorities have resisted rate movements, which results in a misallocation of resources when there is a shift in the equilibrium exchange rate. Counterspeculation by exchange traders reduces the destabilizing effect of central-bank intervention and the consequent loss in economic welfare.