Exchange Rates: Interventions in Currency Markets

okay hi there welcome to a macro video

in this revision topic video we're going

to spend a few minutes looking at the

reasons why a central bank or government

might opt for a managed floating

currency system and also the options for

intervention in currency markets if they

want to influence they want to change

the level of the exchange rate so a

managed floating currency happens when

the central bank chooses to intervene in

the foreign exchange market designed to

affect the value the external value of

one currency against another oftentimes

to meet specific macro economic

objectives which we'll talk about in a

second or two

the latest IMF classification of

countries using a managed floating

system includes the likes of Brazil

South Korea India the Indian rupee is a

managed floating system so to the Thai

Baht the Mexican peso the Japanese yen

many countries actually opt for a

managed floating indeed more countries

or for this than they do for a free

floating system it has an example of a

country which is a free I saw at

currency which is a free float the euro

set against the rupee which is a managed

floating currency you can see that over

the over the long-term of a 17 year

period the Indian rupee has depreciated

against the euro back in 2001 about

forty to forty three rupees would buy

you or your now it's now it's over

eighty why might a central bank perhaps

working in conjunction with the

government why might they try to manage

the currency through intervention well a

central bank might want to bring about a

depreciation of the exchange rate if

they're looking to improve the balance

of trade in goods and services you see a

fall in the currency helps to make

exports more price and cost competitive

in overseas markets but how

a depreciation in the currency is also

targeted favored because of the risk of

a deflationary recession weaker currency

makes import prices more expensive and

again should stimulate to the export

sector or perhaps it's part of a

medium-term shift designed to try to

rebalance an economy away from high

levels of domestic spending on goods and

services tilting more towards increased

export volumes and associated capital


sometimes the central bank wants to

appreciate increase the value of the

currency perhaps because they fear both

demand pull and cost push inflation or

they think that a stronger exchange rate

will help to bring down the cost the

price of imported capital new technology

or essential inputs such as fuel designs

to enhance the long-run growth potential

of a country there are other reasons

I mean generically one reason to manage

the exchange rate is to reduce the

volatility of exchange rates in part

because if the currency is volatile if

the big fluctuations from one month to

another that can increase investor risk

and perhaps damage potential trade and

investment and business confidence if

the risk of overseas investors buying a

government bonds goes up for example

they might demand if you like a premium

interest rates or yield on bonds as

compensation for the volatility in

exchange rates moving on

how can intervention work what can one

of the tools available for central banks

to intervene in the market try to manage

the exchange rate the first option is

direct buying and selling of a currency

by changing reserves of foreign

currencies now this is a crucial point

so to manage a floating currency the

central bank will need enough reserves

or foreign currency available should it

need to intervene

a second option second tool is to change

your own inter

straights so perhaps monetary policy

interest rates might be tilted one way

or the other to achieve a desire to

change in the exchange rate because they

affect flows of hot money across

international financial markets it's

also possible to use the tax system to

manage the exchange rate for example you

might want to tax the interest on

savings of foreign investors in the

country that won't be designed to make

saving and a country less attractive you

might want to tax for example the

profits of overseas subsidiaries let's

quickly look at a currency intervention

summary there hopefully this slide when

we get to the end will be a nice neat

summary for you to to take a look at for

your notes so let's think about direct

intervention first of all we'll bring

the diagrams into play in a second or

two so if you want your currency to

depreciate to go down and value

typically the central bank would go into

the market and they would go into a

currency market and they would sell

their own currency that home currency

and they would buy foreign currency the

result being that foreign currency

reserves would increase if they want me

exchange rate to appreciate they would

go into the market and buy their own

home currency selling foreign currency

reserves as a result those reserves will

diminish here's a good example just

recently when Denmark actually has a

fixed exchange rate against the euro but

there's a good example of the Danish

currencies been under downward pressure

recently and the Danish central bank has

decided to intervene and the foreign

currency market by buying up their own

currency to support the nation's PEC so

they sold just over half a billion

kroner 60 million dollars worth of

currency of course that would add to

their dollar reserves second option one

intervention is through interest rates

so if you wanted your currency to

depreciate to go down in value or an

option would be to lower your loan

interest rates designed to cause a hot

money outflow or perhaps just to

diminish the hot money inflow either way

the currency could fall

again if you wanted the currency to

appreciate you might want to increase

interest rates to attract inflows and

pot money danger of course with that is

that higher interest rates might help to

support the exchange rate but could also

damage consumer spending business

confidence prospects for the housing

market etcetera they could well be a

trade off if you did that there are

alternative interventions if you want

your currency to depreciate and one

option is for the central bank to expand

quantitative easing that increases the

domestic supply of money some of which

will seep out off the economy and

therefore bring the exchange rate down

QE also is designed to reduce the yield

and bonds and if interest rates go down

again that makes an economy less

attractive to hot money flows the

government could also buy assets from

overseas as part of an intervention

strategy if you want your currency to

appreciate well perhaps you you want to

attract money into your currency so you

might reduce taxes on income from assets

to attract overseas investors to buy

your currency analysis diagrams always

useful to get those top KO marks so here

will be an intervention to cause of

currency depreciation the idea here

would be you know going into the market

to sell your currency and buy up foreign

currencies that would shift the supply

curve for currency out to the light

catches pelvis for a given level of

demand that would cause the exchange

rate to fall and if you wanted to

appreciate your currency then the

central bank could go into the market

and buy their own home currency using

reserves of foreign exchange causes the

currency demand for your currency to

shift out to the right and other things

being the same equilibrium value it's

still about of the currency goes up

British Pound is a free floating

exchange rate as it is against the

against as is the US dollar so this

shows the British Pound Sterling to the

US dollar from start of 2015 to autumn


19 and you can see that the pound has

been on a pretty much a downward

trajectory particularly in the aftermath

of the books it left Windham in 2016 and

the parent has been quite volatile range

between sort of $1 20 and $1 nearly $1

60 over this period so with the floating

exchange rate where the Bank of England

doesn't directly intervene oftentimes

you will get quite big movements in the

exchange rate an interesting quote from

the Bank of England from their website

we do not set the exchange rate the UK

has a free floating exchange rate but

our actions can indirectly affect the

value of the pound

in other words interest rates and QE can

have an indirect effect even if the UK

government and the central bank do not

specifically target the exchange rate so

there we go an overview video on

interventions in currency markets