Central Bank Intervention

Central Bank Intervention

Subject: Economy

Context:

Global foreign-currency reserves are falling at the fastest pace on record as central banks from India to the Czech Republic intervene to support their depreciating currencies.

Causes:

• Valuation changes– as the dollar appreciated two-decade highs against other reserve currencies, like the euro and yen, it reduced the dollar value of the holdings of these currencies.
• Central Bank’s Intervention-central banks across the world intervening to support their depreciating currencies.

Central Bank Intervention:

• It is also known as foreign exchange market intervention or currency manipulation,
• It  is a monetary policy tool that involves a central bank taking an active, participatory role in influencing the monetary funds transfer rate of the national currency, usually with its own reserves or its own authority to generate the currency.
• A central bank intervention occurs when a central bank buys (or sells) its currency in the foreign exchange market in order to raise (or lower) its value against another currency.
• Intervention usually happens when a nation’s currency is undergoing excessive downward or upward pressure from market players, usually speculators.
• Types:
  • Verbal Intervention– when officials from the central bank “talk up” (or “talk down”) a currency.
    • This is either done by threatening to commit real intervention (actual buying/selling of currency), or simply by indicating that the currency is undervalued or overvalued.
    • This is the cheapest and simplest form of intervention because it does not involve the use of foreign currency reserves.
  • Operational Intervention-This is the actual buying or selling of a currency by a nation’s central bank.
  • Concerted Intervention-This happens when several nations coordinate in driving up or down a certain currency using their own foreign currency reserves.
  • Sterilized Intervention-When a central bank sterilizes its interventions, it offsets these actions through open market operations.
    • Selling a currency can be sterilized when the central bank sells short-term securities to drain back the excess funds in circulation as a result of the intervention.
    • By definition, sterilized intervention has little or no effect on domestic interest rates, since the level of the money supply has remained constant.
  • Non-sterilization intervention-influences the exchange rate by inducing changes in the stock of the monetary base, which, in turn, induces changes in broader monetary aggregates, interest rates, market expectations and ultimately the exchange rate