Question

How would a market intervention work in the United States? Assume the country wants to make the dollar stronger versus the Euro and is set to use $100 million dollars. Fill in the table below and explain in detail the steps taken in the intervention (make sure you mention the role of the international reserves, the Board of Governors, the Desk at the New York Fed, and the effects on the money supply).

Answer 1

Currency exchange rate is decided by the intersection demand and supply of the currency. Controlling either can influence the currency exchange rate. If dollar needs to be stronger than euro, the demand of dollar must be higher than demand for euro or supply of dollar must be relatively lesser than supply of euro. Market interventions for impacting the exchange rate focused on controlling either demand and supply of price currency relative to the base currency.

Thus if the Fed wanted to make USD stronger than EURO, Fed generally use the monetary policy to control the supply of USD. If supply of USD is decreased, even with no change in demand, USD will become relatively stronger than EURO. Thus to decrease supply of USD, Fed can increase the repo rates which makes it difficult for banks to borrow funds from reserve bank and supply it in market. This as a ripple effect can make USD stronger assuming demand of USd remains same.

USD exchange rate is also impacted by demand for USD which increased or decreased if the imports or exports respectively increased. Thus if the trade related policies favor more exports, then exporters will receive more funds and demand for EURO decreases making USD stronger relative to EURO. International reserves , decisions taken by important agencies like USTDA, EXIM etc. impacts the demand for USD and EURO.

Thus a collective work by multiple parties impacts the currency exchange rate.