Foreign Exchange Market Intervention Amie Colgan, Mary Deely, Fergus Colleran, Anna Nikolskaya

Exchange Rate Intervention Buy or sell foreign currency/assets to affect the exchange rate Purchases push down the home currency value of the exchange rate Sales push it up

Influencing the Exchange Rates Increasing the exchange rate Sell domestic currency and purchase foreign assets money supply production domestic interest rates demand for investment Decreases exchange rate Decreasing the exchange rate Buy domestic currency and sell foreign assets money supply production inflation domestic interest rates demand for investment Increases exchange rate

Why Intervene? Stabilise Fluctuations International trade and investment decisions Dependent on exchange rates Reverse the growth in the country’s trade deficit Rise when exchange rates rise High currency – cheaper foreign goods and services Increasing imports and reducing exports Rising trade deficit – Intervention needed

Types of Intervention Sterilized Intervention – has little or no effect on the exchange rate Unsterilized Intervention – has a higher impact on exchange rates

How does Sterilized Intervention differ from Unsterilized Intervention?

Unsterilized Intervention Central Banks purchase/sell domestic currency to sell/purchase foreign assets which expands/contracts the monetary base. These actions may decrease/increase the money supply which in turn affects prices, inflation and in turn interest rates . Passive approach of intervention by Central Banks. Allows for foreign exchange markets to function without manipulation of the supply of domestic currency. Has a higher effect on interest rates and liquidity.

Unsterilized Intervention Unsterilized Intervention is used when a Central Bank wants to change it’s monetary conditions It has an overall greater effect on money supply interest rates and foreign exchange rates. It takes time to come into effect, not useful if Central Bank wants an immediate change in exchange rates. Has long term effects on the exchange rates. Not used as often because it conflicts with monetary policy.

Sterilized Intervention Buying or selling domestic currency in order to sell or purchase foreign assets to slightly affect exchange rates. This can expand or contract the monetary base. Sterilising means offsetting this expansion/contraction by selling or purchasing government bonds in the domestic bond market to bring back the monetary base to it’s target level. When Central Banks want to leave money supply and interest rates unaffected. Maintains price stability

Sterilized Intervention Intervention in exchange rates without affecting its domestic liquidity. Process limits the amount of domestic currency available for exchange. Altering its debt composition without affecting its monetary base. Sterilised Intervention has little effect on long-term exchange rates. Almost immediate effect on demand and supply of foreign exchange. Affects expectations about future exchange rates, particularly if open market operations are hidden. It’s effect on exchange rates is not as obvious an Unsterilized intervention.

Diagram of Sterilised Intervention where AA and AA’ are the money supply E is the exchange rate Y is GDP F is the equilibrium rate D is demand for money

Effects of Central Bank Action on Exchange Rates May be intentional or not Motivation: (1) Resist short run trends in exchange rates (2) Correct medium-term “misalignments” of exchange rates away from fundamental values Decline in the frequency of intervention

Federal Reserve Quantitative Easing Wed 18/3/09 –Fed announced it is to buy $300 billion in long term treasuries & $750 billion in mortgage-backed securities Create more liquidity –print money Euro rose 3.2% to $1.342 after the statement

Euro/Dollar fx rate Wed 18/3/09 – thurs 19/3/09

Statement of G7 Finance Ministers and Central Bank Governors: “Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability.” 14th February

Swiss National Bank (SNB) 12th March Aim: ‘push down’ Swiss franc SNB cut its 3-month LIBOR target rate by 25 basis points (to historic low of 0.25%) Sold francs for euros and dollars SNB said it’s planning to increase liquidity by Engaging in repo operations Buying Swiss franc bonds issued by private sector borrowers Purchasing foreign currency on the FX market

Swiss Franc Swiss Francs to 1 US dollar Swiss Franc to 1 Euro

Bank of England 5th March Quantitative easing: up to £150 billion up to £75 billion mostly in medium and long-term gilts over next 3 months £50 billion private-sector assets Cut repo interest rate by 50 basis points to 0.5% £ has depreciated against both € and $

British Pound British Pound to 1 US Dollar British Pound to 1 Euro