Discuss the relationship of the direct central bank intervention and its foreign reserve.

Expert Solution

The Central bank intervenes in the market to bring about stability in the foreign exchange market. If there is fluctuations in the foreign exchange market, then traders do not trade in the fear of losing money. In such cases, the central bank intervenes.

Another reason why central bank intervenes is to bring down the appreciation of currency, if the value of currency appreciates rapidly, then trade deficit takes place. The imports rises and exports falls thus rising the trade deficit. Increase in money supply will lead to currency appreciation and decline in money supply can lead to currency depreciation.

the central bank uses its reserves to bring down money supply in case there is inflation in the economy, and also increases the money supply when there is slowdown in the market. Any central bank purchase of assets automatically results in an increase in the domestic money supply , any central bank sale of assets automatically causes the money supply to decline. Central Bank use of foreign exchange reserves helps make purchases and sale.

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Discuss the relationship of the direct central bank intervention and its foreign reserve.

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