Background
Intervention in foreign exchange markets refers to actions taken by central banks or other monetary authorities with the aim of influencing the value of their national currency in relation to others. These interventions often come in the form of buying or selling currencies to stabilize or alter exchange rates.
Historical Context
Currency interventions have a long history, dating back to the Gold Standard era where countries pegged their currencies to a specific amount of gold. In more recent times, interventions became prominent post the Bretton Woods system, which ruled the international monetary landscape from 1944 to 1971, transitioning towards the modern landscape of floating exchange rates.
Definitions and Concepts
Interventions can generally be categorized based on whether they are sterilized or unsterilized:
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Unsterilized Intervention: Occurs when a central bank buys or sells a foreign currency, resulting in changes to the domestic money supply. For example, purchasing foreign currency will increase the money supply, while selling will decrease it.
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Sterilized Intervention: This involves the central bank conducting offsetting transactions (such as selling securities) to neutralize the impact on the domestic money supply when it intervenes in the foreign exchange market.
Major Analytical Frameworks
Classical Economics
Interventions in foreign exchange markets were viewed as disruptions to the natural adjustment mechanisms.
Neoclassical Economics
Generally support minimal intervention, emphasizing market efficiency and the self-correcting nature of free markets.
Keynesian Economic
More supportive of intervention to stabilize economies, buffering against excessive exchange rate volatility which can perturb economies close to full employment levels or during recessions.
Marxian Economics
View currency interventions in the context of broader government controls, power structures, and economic dominance, typically critical of interventions benefiting capitalist systems.
Institutional Economics
Emphasize the role of institutions in shaping the effectiveness and outcomes of interventions.
Behavioral Economics
May justify interventions by considering that exchange rates can be influenced by irrational behaviors, herding, and speculation.
Post-Keynesian Economics
Advocate for strategic intervention to maintain stable exchange rates, supporting full employment and avoiding destabilizing capital flows.
Austrian Economics
Skeptical of currency interventions, as they typically support minimal government interference in the economy.
Development Economics
See interventions as tools to stabilize nascent or volatile economies which are sensitive to external shocks, helping to sustain development goals.
Monetarism
Prefers currency stable frameworks. Monetary authorities should ensure long-term stability rather than short-term object interventions.
Comparative Analysis
Sterilized versus unsterilized interventions are key points for analysis, where the former seeks to neutralize immediate monetary impacts and the latter allows them to propagate. Their usage depends on current economic conditions and monetary policy goals.
Case Studies
- Japanese Yen (2003-2011): Analysis of Japan’s extensive interventions to curb the Yen’s appreciation.
- Swiss National Bank (2015): Handling of the Swiss Franc peg and subsequent decisions impacting the exchange rate.
Suggested Books for Further Studies
- “Exchange Rate Economics: Theories and Evidence” by Ronald MacDonald
- “The Economics of Exchange Rates” by Lucio Sarno and Mark P. Taylor
- “Exchange Rate Regimes and Economic Performance: The Question of Common Causality” by Javad Zarghamee
Related Terms with Definitions
- Sterilization: Monetary authorities’ practice of offsetting foreign exchange interventions to neutralize their effect on the money supply.
- Bretton Woods System: A historical international monetary framework of fixed exchange rates self-correcting by a gold standard post-WWII.
- Floating Exchange Rate: Exchange rates set by natural market forces without direct intervention from central authorities.
