Partial Credibility, Information Selection and the Signalling Channel of Sterilized Interventions

The signalling channel suggests that central banks use sterilized interven - tions in the foreign exchange market to convey information about future mone - tary policy to the market. To date, this theory is not sufficiently supported by theoretical work that establishes the link between intervention signals and exchange rates. This paper develops a two country model of sterilized interven - tions. I argue that reputational effects cannot eliminate the credibility problem between central banks and the private sector and that agents will only partially use available information to form exchange rate expectations. Both partial credibility and non-rational expectations reduce the effectiveness of interven - tions.