I. Introduction
Since the introduction of a floating exchange rate system in February 1973, the Japanese economy has experienced large fluctuations in foreign exchange rates, with the yen on a long rising trend. In order to mitigate the negative influence of such fluctuations on the Japanese economy, foreign exchange market interventions (hereafter "foreign exchange interventions" or simply "interventions") have been conducted from time to time. Although, these interventions have occasionally been reported in newspapers and other news media, the actual operational procedures seem not to be well understood. This article will therefore briefly explain the basics of foreign exchange intervention, focusing on the practical side.
The next section begins with the definition of foreign exchange intervention and goes on to outline its legal status. Section III explains the operation of intervention, including the decision-making procedures. The last section deals with the funding and foreign exchange reserve management that accompany foreign exchange intervention.
II. What Is Foreign Exchange Intervention?
A. Definition and the Legal Status of Intervention
Foreign exchange intervention is defined generally as foreign exchange transactions conducted by the monetary authorities with the aim of influencing exchange rates. In Japan, the Minister of Finance is legally authorized to conduct intervention as a means to achieve foreign exchange rate stability.1 The Bank of Japan, as the agent of the Minister of Finance, executes foreign exchange intervention operations in accordance with the directions of the Minister of Finance.2 The expression "Bank of Japan Intervention," often used in newspapers and other news media, might therefore be misleading (for an international comparison of foreign exchange intervention systems, please refer to the appendix).
1 The Foreign Exchange and Foreign Trade Law stipulates that the "Minister of Finance shall endeavor to stabilize the external value of the yen through foreign exchange trading and other measures" (Article 7, Section 3).
2 The Bank of Japan Law stipulates that the Bank buy and sell foreign exchange "as the agent of the government......,when its purpose is to stabilize the exchange rate of the national currency" (Article 40, Section 2). The Foreign Exchange Fund Special Account Law stipulates that the Minister of Finance may entrust operations involving the Foreign Exchange Fund that are stipulated in the Article 5 to the Bank of Japan (Article 6, Section 1).
B. Types of Foreign Exchange Intervention
Foreign exchange interventions are usually conducted in the Tokyo market. However, as most of the trading shifts to European markets after around 5:00 p.m. JST and then to the New York market, in cases where it is considered necessary to intervene during these hours, the Bank of Japan, as the agent of the Minister of Finance, requests foreign monetary authorities to conduct interventions on behalf of the Bank ("entrustment intervention"). The final decision to use this method is made by the Minister of Finance. The details of the intervention including the amount, currency pair, and method of intervention are also determined by the Minister. The funds necessary for intervention come from the Foreign Exchange Fund Special Account (explained later) irrespective of the market where the interventions are conducted.3 Similarly, when foreign monetary authorities need to intervene in the Tokyo market, the Bank can conduct interventions on their behalf upon request ("reverse-entrustment intervention").4
There are cases where two or more monetary authorities implement intervention jointly by using their own funds at the same time or in succession. This is called "coordinated intervention."
3 "Entrustment intervention" means intervention that is conducted in overseas markets with funds of the Japanese authorities. It is different from the intervention that is conducted in overseas markets with funds of respective foreign monetary authorities.
4 The funds of foreign monetary authorities are used in this kind of intervention.
C. Purpose of Foreign Exchange Intervention
The Foreign Exchange and Foreign Trade Law stipulates that the Minister of Finance shall endeavor to stabilize the external value of the yen by taking necessary measures including foreign exchange transactions.
III. Operational Procedures of Foreign Exchange Intervention
The Bank of Japan conducts foreign exchange intervention operations as the agent of the Minister of Finance, as mentioned earlier. The sections engaged in and responsible for intervention operations are the Foreign Exchange Division of the Financial Markets Department (hereafter BOJ Forex Division) and the Planning and Coordination Division of the International Department.5
5 Before the reorganization of May 2000, as a result of which dealers moved to the Financial Markets Department from the International Department, the former Foreign Exchange Division of the International Department had sole responsibility for the operation. In view of the ever closer linkages between domestic and foreign financial markets and the increasingly active cross-border flow of funds, it is expected that both monitoring and analytical ability will be greatly enhanced by the reorganization.
A. Collecting Information
The BOJ Forex Division closely monitors and analyzes developments in foreign exchange markets day and night through frequent contact with market participants, the Bank's overseas offices, and foreign central banks, as well as utilizing the services of information vendors. In addition, the Forex Division carries out research on developments in the areas which relate to the foreign exchange markets, such as developments in overseas securities and stock markets and commodity prices.
Information gathered in these ways is passed to the Policy Board and other related sections in the Bank as one of the factors on which a judgement of the state of financial and business activities in the Japanese economy is based.6 As the agent of the Minister of Finance, the BOJ Forex Division reports such information every day also to the Foreign Exchange and Money Market Division of the International Bureau of the Ministry of Finance (hereafter MOF Forex Division), which is in charge of foreign exchange intervention in the Ministry.
6 The Bank of Japan provides the public with information on the foreign exchange market through pre-recorded telephone services. This information includes the highest and lowest values as well as turnover, and is revised every hour. (, Japanese only)
B. Foreign Exchange Intervention Decision-Making
When foreign exchange rate developments are regarded as too volatile, the MOF Forex Division gets in touch with the BOJ Forex Division on the hot line, and is supplied with the background information on the volatile movements and other relevant information for making decision on intervention.
If the Minister of Finance decides to conduct intervention based on such information, the MOF Forex Division gives the BOJ Forex Division specific directions for the intervention. The Minister of Finance determines the details taking into consideration various factors in the foreign exchange markets in order to maximize the effectiveness and efficiency of the intervention. The BOJ Forex Division continues to monitor the market developments in parallel with the intervention and provides the MOF Forex Division with information, such as market reactions to it. There are cases where the method of intervention is modified based on the Bank's report.
C. Settlement
Once a dealer of the Bank reaches agreement on the terms of a transaction and makes a contract with the counterparty, the back office takes care of the remainder of the business. The back office in the Planning and Coordination Division of the Bank's International Department is responsible for confirming the terms of contracts made by dealers in the front office and also for carrying out the transactions (i.e., settlement).
Confirmation is done by matching the terms of contracts with the counterparties over the telephone or by SWIFT,7 based on the contract records kept by the dealers. Having confirmed the contract, the back office proceeds to settlement. Settlement for an intervention is made, in principle, through the authorities' accounts at the central bank whose currency is the subject of the intervention.
7 Abbreviation for The Society for Worldwide Interbank Financial Telecommunication, a data telecommunication system for transmitting messages relating to international banking transactions. The headquarters of the system is located in Brussels, and the Bank of Japan has been a member since 1987.
IV. Financing and Investment of Funds for Foreign Exchange Intervention
This section will briefly explain how interventions are financed as well as the basic policy for the investment of foreign exchange reserves, which have been accumulated partly as a result of interventions.
Intervention by the Bank of Japan as the agent of the Minister of Finance is conducted by the account of the Japanese Government, which is called the Foreign Exchange Fund Special Account (hereafter FEFSA).8 This fund consists of foreign currency funds and yen funds. In case of U.S. dollar buying/yen selling intervention, for example, the yen funds to be sold are raised by issuing Financing Bills (FBs). In the event of U.S. dollar selling/yen buying intervention, U.S. dollar funds held in the FEFSA are used for buying the yen in the markets.
The Japanese Government holds large amounts of foreign currencies in the FEFSA, partly as a result of foreign currency buying/yen selling interventions in past yen appreciation phases. The Minister of Finance makes decisions on investments of these currencies paying careful attention to liquidity and safety. Most of these funds have been invested in securities issued by the authorities of major industrial countries, which are almost immune from liquidity risk. The back office also plays a role in the implementation of such foreign currency funds investment.
8 The FEFSA system consists of two elements: the Foreign Exchange Fund and the narrowly defined Foreign Exchange Fund Special Account. The former is a fund prepared for foreign exchange trading by the Government. Purchases/sales of foreign exchange by this fund are not recorded as the revenues/expenses of the Government. In the latter, results of trading such as (1) profits/losses arising from foreign exchange trading and (2) payment/receipt of interest arising from fund-raising/investment accompaning foreign exchange intervention are recorded as the revenues/expenses of the Government.
(Appendix)
United States
Euro Area
United Kingdom
Authority for Intervention
Government (Treasury Department) and Federal Reserve Board (FRB)-- Government has priority with regard to the decision.
European Central Bank (ECB)Intervention should be consistent with the general orientations formulated by ECOFIN.The general orientations are formulated after consulting the ECB, or on a recommendation from the ECB and "shall be without prejudice to the primary objective of the ESCB to maintain price stability."
Government (the Treasury) and Bank of England-- Intervention by BOE is restricted to occasions when it is necessary to attain the monetary policy objective.
Operation of intervention
Federal Reserve Bank of New York
ECB
BOE
Funds for intervention
Government (Foreign Exchange Stabilization Fund) and FRB (usually, each finances half of the amount used for intervention). Intervention results are reported to the Congress every quarter (also published in Federal Reserve Bulletin).
ECB
Government (Foreign Exchange Operation Account) and BOE. The Treasury is planning to disclose intervention on a monthly and quarterly basis on its Web site.
(Box)
A Day in the Life of the Bank of Japan's Foreign Exchange Dealers
-- Written by Masafumi Yamamoto, Foreign Exchange Division
Foreign exchange dealers are, in general, very early birds, and dealers at the Bank of Japan are no exception. We start work before 7:00 a.m. JST when morning trading in the Sydney market in Australia, which starts two hours earlier, peaks out. Our first job is to get ready for the morning market reports meeting by gathering, sorting, and analyzing information. We first check the previous day's developments in the New York and European foreign exchange markets, and then make our own forecasts for the day by listing up bull and bear factors as well as by exchanging views with market participants.
Information we gather ranges over various areas such as economic indicators, statements by high officials, political events, holidays, and rumors circulating in the market. All kinds of media are utilized, including paper media (newspapers, fax news services, magazines), on-line media (computer on-line services, e-mail communication), and voice (telephone conversations). As the volume of information is tremendous, and there is both useful and useless information, we have to screen it and formulate our own view.
There is no time for rest even after the morning meeting. Recently, the improvement in on-line communication media has made it easy for anyone to obtain global information on a real-time basis, dramatically increasing the efficiency of information gathering. However, as the whole market reacts simultaneously even to trivial news, we have to be alert at all times. It is often the case that foreign exchange rates fluctuate abruptly due to unexpected factors. This means that the market has to be analyzed from the standpoints of various areas such as macroeconomic analysis, time-series analysis (which requires sophisticated econometric methods), historical studies, political analysis, and even astrology. Thus, we have to keep on obtaining and analyzing information throughout the day.
Although electronic media have become so popular and useful that we are not able to live without them, conversations over the phone with market participants are still vital for monitoring the markets. Market participants' views occasionally differ significantly and it is often the case that subtle changes in their sentiment gradually grow to a strong trend in exchange rates. Frequent contacts with market participants are the most effective way to remain sensitive to market developments. Communication with market participants is also an important channel for providing them with accurate information on the Bank's monetary policy stance and on the statements of the Bank's officials and thus helps to prevent market reaction arising from misunderstanding.
We look most active when we are conducting intervention. The Bank of Japan, as the agent of the Minister of Finance, conducts foreign exchange transactions (i.e., intervention) in order to stabilize the yen's value. This is stipulated in laws such as the "Foreign Exchange Fund Special Account Law" and the "Bank of Japan Law." Specifically, the Foreign Exchange Division is the operational unit of intervention. When a large fluctuation in the yen is expected to have significant negative effects on the economy, the hot line connected to the Ministry of Finance rings. Several dealers and back-up staff members are quickly on standby, and the tension builds up in the dealing room. When intervention is decided, the room is thrown into an uproar as the dealers and the chief dealer shout their orders and directions.
After 5:00 p.m. JST, the majority of trading shifts to the European market, and usually, the Bank's representative offices in Europe and the United States take over the task of monitoring. It is not until then that we are released from the high tension that started in the early morning. However, when the exchange rates show too much volatility, we cannot close our business even after the Tokyo market closes. It is not uncommon that we continue monitoring during European and U.S. trading time by contacting dealers in overseas markets and people in charge of monitoring foreign exchange markets at foreign central banks. When the Bank of Japan requests foreign central banks to conduct interventions on behalf of the Bank, senior officials of the Bank play the roles of liaison and broker between the Minister of Finance and the foreign central banks. When this happens, work often continues till dawn.
