Case Study: Japanese Intervention in Foreign Exchange Markets Foreign exchange intervention is defined generally as foreign exchange transactions

conducted by a countrys 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. he !an" 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. Japans Foreign #xchange and Foreign rade $aw stipulates that the Minister of Finance shall endeavor to stabilize the external value of the yen by ta"ing necessary measures including foreign exchange transactions. Intervention by the !an" of Japan as the agent of the Minister of Finance is conducted by the account of the Japanese %overnment, which is called the Foreign #xchange Fund &pecial 'ccount (F#F&'). his fund consists of foreign currency funds and yen funds. In case of *.&. dollar buying+yen selling intervention, for example, the yen funds to be sold are raised by issuing Financing !ills. In the event of *.&. dollar selling+yen buying intervention, *.&. dollar funds held in the F#F&' are used for buying the yen in the mar"ets. he Japanese %overnment holds large amounts of foreign currencies in the F#F&', partly as a result of foreign currency buying+yen selling interventions in past yen appreciation phases. he Minister of Finance ma"es decisions on investments of these currencies paying careful attention to li,uidity and safety. Most of these funds have been invested in securities issued by the authorities of ma-or industrial countries, which are almost immune from li,uidity ris". In the *nited &tates, the reasury .epartment and Federal /eserve !oard have -oin authority for foreign exchange intervention0 however, the reasury .epartment has priority with regard to the decision. 1nce the decision to intervene is made, the policy is carried out by the Federal /eserve !an" of 2ew 3or". here are cases where two or more monetary authorities implement intervention -ointly by using their own funds at the same time or in succession. his is called 4coordinated intervention.4 Japans Post Bretton Woods Intervention &ince the demise of the !retton 5oods #xchange /ate &ystem in the early 6789s, Japan has been one of the largest interveners in foreign exchange mar"ets. !etween 'pril 6776 and .ecember :999, for example, the !an" of Japan bought *.&. dollars on 6;< occasions for a cumulative amount of =>9? billion and sold *.&. dollars on >> occasions for a cumulative amount of =>< billion.

Japanese intervene overshadows all other countries@ official intervention in the foreign exchange mar"et0 exceeding *.&. intervention over the 'pril 6776 to .ecember :999 period by a factor of more than >9. It should be pointed out, however, that the magnitudes of any central ban" intervention, including those by the !an" of Japan, are very small compared to overall mar"et transactions in the foreign exchange mar"et. Japanese intervention from 6776 through :999 is charted in Figure 6.

's seen in the above chart, during this period, intervention can be divided into three subAperiodsB (6) 6776A677C, (:) 6778A7<, (>) 6777A:999. .uring subAperiod 6 (6776A677C), !an" of Japan intervention generally involved buying *& dollars, especially from 677> on. .uring the period from 677> to mid 677C, the yen was a very strong currency against the *& dollar (the yen reached a post !retton 5oods high of <6.98 on 'pril 67, 677C). In an attempt to offset, or moderate, yen strength, the !an" of Japan intervened by buying dollars, the wea" currency (and selling yen, the strong currency). he chart below trac"s the exchange rate from January 6, 677> through July 677C. In January 677> the exchange rate stood at 6:C (in #uropean terms) and by 'pril 677C the yen had strengthened to -ust under <C.

.uring subAperiod : (6778A7<), !an" of Japan intervention involved selling *& dollars (buying yen). he amount of sales was especially large in late 6778+early 677<. 's shown in the chart below, during this time the yen wea"ened against the *& dollar from a high of 66C in mid 6778 to a low of over 6?9 in July 677<. .uring this time, the !an" of Japan was attempting to offset, or moderate, this wea" yen through the selling of dollars, the strong currency (and purchasing of yen, the wea" currency).

Finally, during the third subAperiod, 6777A:999, !an" of Japan intervention involved the buying of *& dollars (selling yen). .uring this period, especially from early 6777 to the end of that year, the yen was very strong against the *& dollar. In May 6777 to exchange rate stood at around 6:: and by .ecember 6777 the yen had strengthened to around 69:. he buying of dollars, the wea" currency (and selling yen, the strong currency) in 6777 was an attempt to counter, or moderate, the strengthening yen. he continued buying of dollars into :999 was a continuation of this policy.

&ince March of :99?, the !an" of Japan has not intervened in foreign exchange mar"ets in support of the yen. .uring this period of time, especially from January 6, :99C the yen has generally wea"ened against the *& dollar.

Is Intervention Success u!" &ince few studies have found evidence supporting a lin" between intervention and exchange rates, many professional economists tend to be s"eptical about whether official intervention could (or should) play an important role as an effective policy instrument to influence exchange rates. he most positive study (Dutchison, :99>) suggested some success as measured in either slowing or reversing the direction of exchange rate change out to periods of up to two wee"s. 'fter that period of time, mar"et fundamentals become dominate once again. he issue for central ban"s is really two fold. First, their intervention activities, by their very nature, can only be small relative to the size of the foreign exchange mar"et itself. &econd, given that any positive effects are short term, and then mar"et forces come to dominate, central ban"ers probably should consider very carefully whether this use of their reserves is appropriate. Eentral ban"ers in the developed world appear to have moved away, or are moving away, from foreign exchange intervention. !efore we give up on this type of policy we should recognize that there might be situations associated with unusual and extreme mar"et aberrations where intervention might be -ustified for very short term effects. &ince this is a possibility, we should not rule out the use of central ban" interventions in the future.