Central bank intervention in foreign exchange
Central bank intervention in foreign exchange refers to actions taken by a country’s central bank to influence the value of its currency in the foreign exchange market. This can be done in a number of ways, including:
- Direct intervention: The central bank buys or sells its own currency in the foreign exchange market to influence its value. For example, if a central bank wants to weaken its currency, it may sell its own currency and buy foreign currencies.
- Interest rate policy: Central banks can adjust their interest rates to influence the value of their currency. For example, if a central bank raises its interest rates, it may attract more foreign investment and strengthen its currency.
- Reserve requirements: Central banks can also adjust the reserve requirements for banks, which can affect the amount of money banks can lend and the level of economic activity. This can indirectly influence the value of the currency.
The goal of central bank intervention in foreign exchange is to stabilize the value of the currency and maintain economic stability. However, there are risks involved with central bank intervention, including the potential for unintended consequences and market disruption.
Central bank intervention is most commonly used by countries with floating exchange rates, where the value of the currency is determined by market forces, rather than fixed exchange rates, where the value of the currency is pegged to another currency or a basket of currencies.
Practice Questions
1. What is central bank intervention in foreign exchange?
A) Buying or selling foreign currency
B) Adjusting interest rates
C) Actions taken by a country’s central bank to influence the value of its currency in the foreign exchange market
D) Adjusting reserve requirements
Answer: C) Actions taken by a country’s central bank to influence the value of its currency in the foreign exchange market
2. What is the goal of central bank intervention in foreign exchange?
A) To make a profit
B) To destabilize the value of the currency
C) To maintain economic stability
D) To create market disruption
Answer: C) To maintain economic stability
3. Which of the following is an example of direct intervention by a central bank in foreign exchange?
A) Adjusting interest rates
B) Adjusting reserve requirements
C) Buying or selling its own currency
D) None of the above
Answer: C) Buying or selling its own currency
4. In which type of exchange rate system is central bank intervention most commonly used?
A) Fixed exchange rates
B) Floating exchange rates
C) Managed floating exchange rates
D) None of the above
Answer: B) Floating exchange rates
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