Reverse currency wars

It has been argued that the early 1980s were such an example. When the Fed, under Chair Paul Volcker, raised interest rates sharply to fight inflation, it knew that it would be aided by an appreciation of the dollar. But the corresponding depreciation of trading partners’ currencies worsened their inflation rates and forced them to raise interest rates as well. The worry was that the world ended up with higher interest rates than were desirable. The 1985 Plaza agreement to bring down the dollar ended this period of competitive appreciation.

Current intervention models combine financial frictions with relevant externalities: with the aggregate demand and pecuniary externalities that now inform macroeconomic models more broadly, and with the trade-related learning externalities that are particularly relevant for developing and emerging economies. These models characteristically allow for normative evaluation of the use of intervention, though most (but not all) do so from a single economy perspective.

Empirical advances reflect the advantages of more variation in the use of intervention, better data, and novel approaches to addressing simultaneity. Intervention is now widely seen as influencing exchange rates at least to some extent; and sustained one-sided intervention and its corresponding reserve accumulation appears to play a role in moderating exchange rate fluctuations, and in reducing the likelihood and damaging consequences of financial crises.