Foreign Exchange Intervention - Bank of Sierra Leone

11. (Cont’d.)
There were two main planks to this argument. First, there was a
view that the market would get it right without our help
(efficient market hypothesis), and so intervention could only
make things worse. Second, there was a view that central banks
usually lose money through intervention and therefore their
efforts must have been destabilizing.
However, others believed that Foreign Exchange intervention is
very effective as a policy tool.
There is no disagreement, either theoretical or empirical, that
non-sterilized foreign exchange intervention significantly
affects the exchange rate. A non-sterilized foreign exchange
operation amounts to a change in the domestic supply of
money, and all models predict that changes in the stock of
money affect the nominal exchange rate, both in the short run
and in the steady state. The effectiveness of non-sterilized
intervention is clearly evident in the empirical exchange rate
models (Driskill and Sheffrin (1981) and Frenkel (1981).