On central bank interventions and transaction taxes

Abstract

We show that carefully designed central bank interventions may have a similar (stabilizing) effect on foreign exchange dynamics as transaction taxes. Transaction taxes seek to curb speculative activity. If speculators consist of chartists and fundamentalists – as indicated by many empirical studies – central banks may seek to replicate the impact of transaction taxes by countering the orders of these traders. This would simultaneously require trading against the current exchange rate trend and, surprisingly, slowing down the convergence of the exchange rate towards its fundamental value.