Question

Suppose that a certain country is facing a widening current account deficit and rising inflation. As a result, its currency is starting to face downward pressure in the foreign exchange market. Explain what is meant by currency market intervention and the three main methods of intervention the country could use to try to protect the value of its currency.

Answer 1

When a certain country is facing current account deficit due to rising inflation and the currency is starting to slide downwards, then Central Bank can intervene through various types of intervention plans. Central banks starts to to buy or sell its domestic currency into the the foreign exchange market in order to support its currency and control the devaluation of its currency.it could be done through three methods they are as follows-

1. Sterilized intervention-this type of intervention reflects that central bank is buying and selling foreign exchange in the market with the the aim to influence the exchange rate. If the action has no in effect on short term interest rate, it is sterilized intervention.

2. Operational intervention-this is a type of intervention in which concrete buying or selling of the foreign currency takes place. it is most efficient and effective.

3. Concerted intervention-these interventions are more like jawboning in which there is more talking and less doing. Central Bank issue such statement that influence the exchange rate in the market rather than doing any kind of operational intervention.