How Central Bank Intervene In Foreign Exchange Market Case Study
The central banks generally attempt to achieve inflation around 2%. Inflation hinges on how much money is in circulation, the money supply. However, the central bank cannot directly control the money supply but rather uses different tools to achieve its target. As the money supply cannot be controlled, other actors tug the number up and down, for which it may differ from its desired state. Interest rates, on the other hand, as one such instrument that influences the money supply, can more easily be altered as they closely relate to the progression of the fed funds rate, which, in turn, orients itself on the federal discount rate (International …show more content…
Fixed interest rates on the other hand allocate resources efficiently (Khan, 2008). In conclusion, money supply and interest rates do not relate one to one.
CENTRAL BANKS, MONEY SUPPLY, INTEREST RATES, AND FX 3
2. How do central banks intervene in foreign exchange markets?
Central banks intervene in foreign exchange markets via what’s labeled unsterilized foreign exchange interventions — the purchasing and putting up of international reserves, i.e. assets denominated in foreign currencies, with the local currency. They do this in case the currency becomes too strong or weak to be good for the economy. As foreign reserves are sold, the money supply increases and thereby depreciates the domestic currency. However, as Thailand realized, once the central bank runs out of international reserves, it can turn to a costly endeavor, as debts denominated in foreign currencies are now much costlier to repay. Besides, affecting the monetary base by doing so, in one way or the other may go counter to what the economy actually requires at the time when the focus lies on the currency value instead (Wright & Quadrini, 2009,
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What did the Bretton Woods Agreement do to the ability of foreign exchange rates to fluctuate freely?
After World War I the motivation to collaborate for prosperity and create an international financial system was large enough for 44 countries to meet in rural Bretton Woods in 1944. At the meeting they partly dropped the gold standard and replaced it with the US dollar standard, the only currency to emerge with a strengthened economy. Every other nation agreed to keep their exchange rate fixed to the dollar and the IMF would monitor and help out, as a lender of last resort, with short-term loans to avoid devaluation by printing currency. The World Bank