Post-Louvre Intervention: Did Target Zones Stabilize the Dollar?

At their Louvre meeting in February 1987, the Group of Seven (G7) countries agreed to stabilize dollar exchange rates. Over the next two years, central banks frequently bought and sold dollars in a manner broadly consistent with attempting to maintain target zones, and dollar exchange rates appeared more stable than they previously had been.

This paper investigates claims that the G3 (Germany, Japan, and the United States) successfully maintained target zones following the Louvre meeting. We use daily, official intervention data and simultaneous-equation techniques to estimate Probit reaction functions and GARCH exchange-rate equations. From the reaction functions, which include variables for target zones and market disorder, we construct Mill's ratios to serve as instruments for intervention. We introduce the Mill's ratios into both the conditional mean and conditional variance of the exchange-rate equations.

The results suggest that the G3 reacted to exchange-rate movements in a manner broadly consistent with maintaining target zones. With some notable exceptions, however, we do not find strong evidence that the intervention successfully influenced subsequent exchange-rate movements.