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Central Bank Intervention under Target Zones: The Portuguese Escudo in the ERM

2003; RELX Group (Netherlands); Linguagem: Inglês

1556-5068

Jorge Braga de Macedo, Luís C. Nunes, Luís Brites Pereira,

Economic Policies and Impacts

For Portugal, the transition to the Euro began in September 1989 and featured three successive institutional arrangements related to the Exchange Rate Mechanism of the European Monetary System: shadowing it, belonging to it with 6% and then with 15% fluctuation bands. Using daily data, we study how the degree of mean reversion of the exchange rate and central bank intervention reflect the change in economic regime towards stability and convertibility. Our Markov regime-switching framework with an EGARCH specification allows for deviations from central party and intervention to affect the mean, the conditional variance and the state transition probabilities in the different policy regimes. Mean reversion is significant even when volatility is high in ERM-6, unlike central bank intervention, which almost disappears in ERM_15. Intervention affects the mean and the variance of the exchange rate when volatility is low, and the variance in ERM-S, even when volatility is high.