Edited by Klaus Liebscher, Josef Christl, Peter Mooslechner and Doris Ritzberger-Grünwald
Chapter 11: Using the Microstructure Approach to Foreign Exchange Markets in a Central Bank
Áron Gereben1 INTRODUCTION 11.1 In recent years the analysis of currency markets and exchange rates using the tools of market microstructure theory has gained popularity in the academic literature. Although these methods are not yet considered to be a part of the standard toolkit of central bank analysts, some of the results they yield could be potentially used for providing regular decision-making support and policy advice in central banks. The aim of this chapter is to give an overview of the research on the foreign exchange (FX) microstructure conducted at the Magyar Nemzeti Bank (the central bank of Hungary, MNB), and to highlight some of the policy-relevant applications. The structure of the chapter is the following. The next section highlights the importance of the exchange rate in the conduct of monetary policy in Central and Eastern European (CEE) economies in general, and in Hungary in particular. The third section presents our main motivating factors to study the microstructure of the FX market. The fourth gives insights into our data sources. The ﬁfth summarizes the key research results we obtained. To conclude, the ﬁnal section elaborates on the potential for policy-related, practical applications of the microstructure approach for a central bank. 11.2 WHY DO WE CARE ABOUT THE EXCHANGE RATE? There are several reasons why the MNB considers the exchange rate as a factor of key importance when conducting monetary policy. Hungary is an emerging market and, as such, its ﬁnancial markets are relatively vulnerable to global, regional and internal shocks....
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