A foreign exchange intervention is a monetary policy tool in which a central bank takes an active participatory role in influencing the monetary funds transfer rate of the national currency. Central banks, especially those in developing countries, intervene in the foreign exchange market in order to build reserves, stabilize the exchange rate and to correct misalignments.
The success of foreign exchange intervention depends on how the central bank sterilizes the impact of its interventions, as well as general macroeconomic policies set by the government. Two difficulties that central banks face are determining the timing and amount of intervention, as this is often a judgment call rather than a cold, hard fact.
The amount of reserves, the type of economic trouble facing the country, and the ever-changing market conditions make taking the best course of action difficult. Foreign exchange intervention comes in two parts. Firstly, a central bank or government may assess that its currency has slowly become out of kilter with its economy and is having adverse affects on it. By weakening its currency it is making the products it exports more competitive on the global market.
During the oil crisis in , many Middle Eastern countries that peg their currency to the U. Remember oil prices are denominated in U. Secondly, intervention can be a short-term reactionary to a certain event. Often, times a one-off event may cause a countries currency to move in one direction in a very short space of time. Central banks will intervene with the sole purpose of providing liquidity and reducing volatility.
Foreign exchange interventions can be risky in that they can undermine a central bank's credibility if it fails to maintain stability. Defending the national currency from speculation was a precipitating cause of the currency crisis in Mexico, and was a leading factor in the Asian financial crisis of Dictionary Term Of The Day.
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A celebration of the most influential advisors and their contributions to critical conversations on finance. Become a day trader. Foreign Exchange Intervention Share. What is a 'Foreign Exchange Intervention' A foreign exchange intervention is a monetary policy tool in which a central bank takes an active participatory role in influencing the monetary funds transfer rate of the national currency.
Risks Foreign exchange interventions can be risky in that they can undermine a central bank's credibility if it fails to maintain stability. Get Free Newsletters Newsletters.More...