Should Central Bank Intervention in the Foreign Exchange Market Be Secret?

What is it about?

We analyze an asymmetric information model of sterilized intervention in the foreign exchange market. We characterize an equilibrium in which a central bank with "inside information" about its exchange rate target trades with risk averse speculators who have private information about future spot rates. The model identifies circumstances in which “perverse” responses to intervention will be observed i.e. the domestic currency depreciates when the central bank purchases it, and it provides conditions under which the exchange rate will be highly sensitive to intervention. The model also provides an explanation for two forms of "policy secrecy": (i) secrecy about the scale of an intervention operation is always desirable, (ii) secrecy about the target is sometimes desirable.

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Why is it important?

This was the first paper to formalize the game played between central banks trying to stabilize their currency and speculators wanting to "attack weak currencies". It showed what pieces of information the central bank should keep secret, and why.

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