Exchange-rate Intervention: Arbitrage and Market Efficiency

Under the Bretton Woods system of pegged rates of exchange between currencies, intervention by the United States in the currency market was redundant, since the monetary authorities abroad determined the foreign-exchange rate of the dollar as they bought and sold their own currencies within the support limits around their parities. With the breakdown of the Bretton Woods system, the authorities in the United States faced a new problem—should they intervene in the foreign-exchange market or should they instead follow a policy of benign neglect, so that the value of the American dollar, in terms of various other currencies, would be determined by some combination of market forces and the intervention policies of foreign monetary authorities? Prior to the breakdown, it was generally believed that official intervention would be far less extensive with a floating exchange-rate regime; the irony, however, is that official transactions in reserve assets have been substantially larger under the floating exchange-rate system than under the pegged exchange-rate system. These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.