Money Market Interventions (PDF)

Essay from the year 2003 in the subject Business economics - Banking, Stock Exchanges, Insurance, Accounting, grade: 1,5 (A), Oxford Brookes University (Business School), course: Synoptic Essays in International Banking & Finance, language: English, abstract: After the collapse of the Bretton-Woods-System in 1973 and the transition to a
system of floating rates between the major global currencies, central banks still use
interventions for exchange rate maintenance. This paper aims to examine the
function of Central Bank operations in foreign exchange markets on the basis of two
empirical data sets, explaining both, appreciation and depreciation. It tries to analyse
the impacts on capital flows recorded in the balance of payments and the efficiency
of interventions. Further it will analyse the impacts on domestic monetary supplies
and if necessary how to sterilise these effects. At certain stages endnotes will refer to
the appendix for more detailed explanations or data. To illustrate, how central bank interventions work, we will take the European Central
Bank (ECB) as an example and concentrate on two currencies, the euro (EUR) and the
US dollar ($). [...] If the ECB aims at an appreciation of the own currency, the bank will engage in a
foreign exchange operation and buy euros against its US dollar reserves. The
demand for euros increases (demand curve shifts to the right) and simultaneously supply is reduced, because the ECB takes Euro out of the market (supply curve
shifts to the left). Through the forces of supply and demand the value of the euro will
strengthen in international markets (the exchange rate moves from r1 to r2).
Depreciation (see diagram 2)
If the ECB aims at a depreciation of the own currency, the bank will sell euros against
dollars. In this case, demand for euros declines (demand curve shifts to left) and the
supply increases (shift to the right) because the ECB pays the purchased dollars in
euro. Again, the forces of supply and demand determine the new exchange rate at r2.
The value of the euro will weaken in international markets (and inversely the US
dollar value will rise). [...]