Since 2008, the RBA has not intervened in the foreign exchange market as liquidity in the Australian dollar has been acceptable, notwithstanding the fact that the Australian dollar exchange rate has traded in a wide range.
So why does the RBA intervene in the FX market? This is a curly question for the central bank. In short, because it thinks the market has become inefficient, and there is insufficient liquidity for proper price discovery. These are the same arguments I used for the government's RMBS interventions via the AOFM, which they have put $20 billion behind. The authors explain the evolution of interventions as follows:
With the need to ‘test and smooth’ now much diminished, the focus of intervention evolved towards responding to episodes where the exchange rate was judged to have ‘overshot’ the level implied by economic fundamentals and/or when speculative forces appeared to have been dominating the market. This shift resulted in less frequent, but typically larger, transactions. Reflecting the focus on redressing instances of exchange rate misalignment, switches between sales and purchases of foreign exchange were also somewhat less frequent than during the ‘testing and smoothing’ period. Periods where the exchange rate was judged to have ‘undershot’ were typically countered by a series of sales of foreign exchange reserves (purchases of Australian dollars), and periods where the exchange rate was judged to have ‘overshot’ were typically addressed through a series of foreign exchange purchases (sales of Australian dollars). This approach to foreign exchange intervention continued through to the early 1990s...
From the early 1990s, the threshold for what constituted an ‘overshooting’ in the exchange rate became much higher: a moderate misalignment was no longer considered sufficient to justify an intervention. This gradual change in the RBA’s approach occurred as the foreign exchange market became increasingly developed and much less volatile than it had been in the late 1980s. But, more importantly, market participants had become better equipped to manage volatility, particularly through hedging. Accordingly, the main focus of intervention shifted to episodes that could be characterised by evidence of significant market disorder – that is, instances where market functioning was impaired to such a degree that it was clear that the observed volatility was excessive. Reflecting this, the previous pattern of alternating foreign exchange sales and purchases was replaced by a series of less frequent sales of foreign exchange (with no interventions in the form of foreign exchange purchases recorded after mid 1992, Graph 3). The one-sided nature of these interventions reflected concerns regarding market conditions when the exchange rate had been facing depreciation pressures...
From the early 1990s, the threshold for what constituted an ‘overshooting’ in the exchange rate became much higher: a moderate misalignment was no longer considered sufficient to justify an intervention. This gradual change in the RBA’s approach occurred as the foreign exchange market became increasingly developed and much less volatile than it had been in the late 1980s. But, more importantly, market participants had become better equipped to manage volatility, particularly through hedging. Accordingly, the main focus of intervention shifted to episodes that could be characterised by evidence of significant market disorder – that is, instances where market functioning was impaired to such a degree that it was clear that the observed volatility was excessive. Reflecting this, the previous pattern of alternating foreign exchange sales and purchases was replaced by a series of less frequent sales of foreign exchange (with no interventions in the form of foreign exchange purchases recorded after mid 1992, Graph 3). The one-sided nature of these interventions reflected concerns regarding market conditions when the exchange rate had been facing depreciation pressures.
