RBI's Intervention in Foreign Exchange Market

In the aftermath of the currency crises around the world, the role of the central banks' interventions in the foreign exchange market has gained in importance. It is obvious that such intervention affects the exchange rate in two ways, first, by affecting the extent of excess demand in the foreign exchange market, and thereafter through a complex interplay of the macroeconomic variables. The stylised literature has addressed this issue by estimating the so-called offset coefficients, a method that is ad hoc and that is marked by the conspicuous absence of an underlying macro-model. In this paper, we build on the stylised Mundell-Fleming model, and derive an estimable reduced form expression that allows us to link exchange rate movements with the RBI's interventions. The model itself, and the subsequent empirical result indicate that the effect of RBI's intervention in the foreign exchange market is at best unclear. Specifically, given the time span of the data, the RBI's interventions in the market seem to have been ineffective.