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

Currency market intervention is an intervention by the central banks into the foreign exchange market in which Central banks buys or sales its own currency in order to control the interest rate and the inflation or devaluation of domestic currency.

currency market intervention is buying or selling of domestic currencies and foreign bonds in order to influence the exchange rate.

Three main type of currency intervention are as follows-

1. Sterilized intervention-in this type of intervention Central banks conduct different type of operation that affect the exchange rates in the market but it does not affect the overall trade positions so this is a type of intervention which is sterilized.

2. Jawboning - this type of interventions are done by central banks which are more talking and less doing. they tend to talk aggressively in order to bring the currency rate into control .

3. Operational intervention-this kind of interventions are done by Central Bank by buying and selling of the currencies into the foreign market in order to stabilize the exchange rate into its own control.Operational intervention can cause significant dent in the overall forex reserve held by the central bank.