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USD – Euro Exchange Rate History 1 euro = 1.27

USD – Euro Exchange Rate History 1 euro = 1.27

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Government Intervention
• Monetary intervention is performed by the Central Banks
• in the US the Federal Reserve Bank or the FED is the central bank
• Reasons for central bank intervention
• To smooth exchange rate movements
• To establish exchange rate boundaries
• To respond to temporary disturbances
• Often, intervention is overwhelmed by market forces. However,

currency movements may be even more volatile in the absence of
intervention.

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Government Intervention
Fed exchanges $ for £
to strengthen the £
Value
of £

S1

V2

Fed exchanges £ for $
to weaken the £
Value
of £

S1
S2

V1

V1

D2
D1
Quantity of £

V2
D1
Quantity of £

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Intervention
• Studies have confirmed
• That government intervention does not have a permanent impact
on exchange movements
• That in many cases intervention is overwhelmed by market forces
• The intervention does have an impact on currency volatility
• Direct Intervention
• As an example the FED can force the dollar to depreciation by:
• Exchange dollars it holds in reserve for other foreign currencies
• By flooding the market with dollars it puts downward pressure on the

dollar - increase the supply demand will drop.
• With the high reliance on currency reserves central banks like China
have a much greater ability to effect the market.
• Many time several central bank will coordinate actions

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Sterilized vs. Non-Sterilized Intervention
• Non - Sterilized - Central Bank intervenes without

adjusting for the money supply
• Sterilized – Central Bank intervenes in Foreign exchange
marker and simultaneously in an off setting transaction in
Treasury securities market. (∴) the money supply is
unchanged.
• As an example if the central bank desires to strengthen foreign

currency and devalue the local currency without effecting the
money supply, it exchanges local currency for foreign currency
(∴) increasing the supply of local currency and then sell some of
its holding in treasury notes for local currency – (∴) taking
reducing the supply of local currency.

International Executive Master of Business Administration

Government Intervention
• Central banks can also engage in indirect intervention by

influencing the factors that determine the value of a
currency.
• For example, the Fed may attempt to increase interest
rates (and hence boost the dollar’s value) by reducing the
U.S. money supply.
• Note that high interest rates adversely affects local borrowers.

International Executive Master of Business Administration

Intervention as a Policy Tool
• Like tax laws and money supply, the exchange rate is a

tool which a government can use to achieve its desired
economic objectives.
• A weak home currency can stimulate foreign demand for
products, and hence local jobs. However, it may also lead
to higher inflation.

International Executive Master of Business Administration

Weak and Strong Currencies
• Weak Currency (reduce interest rates)
• Can substantially increase foreign demand for
its products
• Can reduce unemployment
• Can reduce imports
• Also stimulates the economy by reducing the
cost of borrowing by companies.
• Strong Currency
• Can promote consumers to purchase products

from other countries – (∴) local companies
resist raising prices and increase
competitiveness (∴) reducing inflation.

International Executive Master of Business Administration

Government Intervention
• Governments may also use foreign exchange controls

(such as restrictions on currency exchange) as a form of
indirect intervention.
• A strong currency may cure high inflation, since the
intensified foreign competition should cause domestic
producers to refrain from increasing prices. However, it
may also lead to higher unemployment.

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The Central Bank Can Influence
• Change in differential between the US inflation and





Foreign country inflation
Change in differential between the US interest rate and
the foreign country interest rate
Change in the differential between the US income Level
and the foreign country's income level
Change in government controls
Change in expectations of future exchange rates

Essentially all the factors that effect the currency
Spot Rate.
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The Asian Crisis (1997)
• Prior to 1997 Thailand baht was linked to the USD.
• Was one of the worlds fastest growing economies.

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The Asian Crisis – Cont.:
• Stable Baht made Thailand an attractive site for foreign







investment. They could earn a high rate of interest.
The large inflow of funds was more than the banks could
handle (∴) the banks in an effort to move the funds made
risky loans. Commercial developers borrowed heavily.
Funds could only be paid back to banks if the country
continued its high growth rate.
Large inflow of foreign funds also made Thailand
susceptible to a quick and massive outflow of funds.
Inflow of funds put a downward pressure on interest rates.
The government was also borrowing heavily to improve its
infrastructure
International Executive Master of Business Administration