Central bank verbal communication in China’s FX market: a nonlinear coordination channel approach

This paper investigates the role of central bank verbal communication in China’s foreign exchange market, focusing on the coordination channel through which communication influences exchange rate dynamics and market expectations. We develop a heterogeneous agent model where fundamentalists’ confidence depends on exchange rate misalignment and central bank communication. The model indicates that verbal communication can strengthen market coordination and accelerate the exchange rate’s reversion towards its fundamental value. Empirically, we construct a novel index related to central bank verbal communication based on official statements and examine its effects using a Smooth Transition Regression GARCH (STR-GARCH) model. Our results show that PBOC verbal communication is associated with changes in exchange rate dynamics and volatility, consistent with the coordination mechanism. We conduct a series of robustness checks and address potential endogeneity concerns arising from the central bank’s reaction to market conditions. This study contributes to the literature on foreign exchange intervention and expectation management by providing new evidence on the role of verbal communication in a managed exchange rate regime.