Central Bank Intervention, Exchange Rate Regime and the Purchasing Power Parity

Abstract

Motivated by the argument that central bank intervention leads to non‐linear exchange rate adjustment processes, we examine purchase power parity (PPP) by applying quantile unit root tests to the exchange rates of the New Taiwan Dollar (NTD) vis‐à‐vis seven Asian currencies. We show that exchange rate regime matters in determining whether PPP holds. While PPP holds overwhelmingly during the period when the NTD is under the fixed exchange rate regime, it is present only for some exchange rates during the managed floating rate regime. For exchange rates exhibiting mean reversion, the reversion occurs mainly when the shocks are large. In contrast to conclusion in the literature, our test results show little evidence of asymmetric mean reversion between positive and negative shocks.

Exchange Rate Regimes in India: Central Bank Interventions and Purchasing Power Parity in the Context of ASEAN Currencies

“…This supports PPP validity during the fixed regime and not during the managed floating regime, which may indicate that irregular central bank interventions in the managed floating regime may cause deviations from the exchange rate. This argument aligns with the findings of Lin and Lee (2016). The significant negative ECTs across all regimes in the VECM also indicate that the equilibrium is corrected by the depreciation of the currencies.…”

“…In this paper, we examined the interplay between RBI's interventions and PPP in two distinct exchange rate regimes, the fixed exchange rate (1975)(1976)(1977)(1978)(1979)(1980)(1981)(1982)(1983)(1984)(1985)(1986)(1987)(1988)(1989)(1990)(1991)(1992)(1993) and the managed floating exchange rate . Employing Johansen's Cointegration tests and VECM, our findings reinforce the view that central bank interventions significantly impact exchange rate adjustments (Lin and Lee 2016).…”

“…Another exchange rate regime worth noting is the managed floating regime, where a country's central bank intervenes only during substantial exchange rate shocks. Lin and Lee (2016) studied Taiwan's exchange rate behavior under both fixed and managed floating systems. They found that PPP holds more robustly under a fixed system but is only partially established in a managed floating system.…”

“…This concern is especially relevant for export-oriented economies, where a stronger currency can make exported goods more expensive and less competitive, impacting overall exports. Lin and Lee (2016) studied the New Taiwanese Dollar during both fixed and floating rate regimes. Under the fixed system, long run PPP held true, especially when the central bank frequently intervened to maintain stability.…”

“…Enders (2015) proposed that panel unit root tests considering cross-sectional dependence among countries may possess greater power in identifying mean-reverting properties of RERs, which is crucial for PPP. However, this approach encountered challenges, including inconsistencies in long-term data across various exchange rate regimes, potential structural shifts in the economy affecting the equilibrium RER, and errors arising from assuming the stationarity of all series in the panel (Lin and Lee 2016).…”