Currency manipulation and currency wars: Analyzing the dynamics of competitive central bank interventions

Abstract

Based on a behavioral exchange rate model, we show that a central bank that conducts competitive interventions to promote its economy may devalue its currency, albeit at the expense of creating heightened exchange rate volatility. However, currency manipulation may easily spark currency wars, i.e. rival central banks may retaliate by conducting competitive interventions, too. We find that the central bank that intervenes more aggressively during a currency war may succeed in devaluing its currency, yet the exchange rate's volatility may increase significantly. If both central banks act equally aggressively, a currency war merely amplifies exchange rate fluctuations.