Effectiveness of central bank interventions in foreign exchange market: a case study of IFEM in Tanzania, 2000-2007

The Tanzania economy went through liberalization in 1991 and from which the shilling was float after amendment of financial institutions and banking act of 1971. Since then the bank of Tanzania began intervention in the foreign exchange market. This dissertation studies the effectiveness of central bank intervention in foreign exchange market. A case study of IFEM for the period 2000 to 2007. The study has its null hypothesis that foreign exchange volatility is successfully contained by the central bank actions. In this study nominal exchange rate has been used to generate exchange rate volatility. The study employs GARCH (1,1) to simultaneously estimate the effect of interventions on the mean and exchange rate volatility. Using official monthly exchange rates and official interventions data, the empirical results suggests that interventions activities of bank of Tanzania depreciate the shilling, and there is little evidence in containing exchange rate volatility. In line with similar finding elsewhere in the literature, this thesis finds that net sales of dollars by BOT depreciate rather than appreciate the shilling. Moreover, the findings further shows that BOT interventions reduces the volatility of shillings but the impact is neither statistically nor economically significant. However, these findings reserve further research using daily data. Given the data limitations, this study, however advice that BOT should intervene to address short-term disorderly market conditions, when the market movement is against fundamentals.