If the exchange rate volatility increases the risk of holding domestic assets, then prices of these assets would also become more volatile. Moreover, the exchange rate fluctuation would spill over into the other financial markets. Firms are reluctant to engage in international trade. As a result, investors are unwilling to make investment in foreign financial assets. When there is inordinate instability, exchange rate uncertainty generates extra costs and reduces profits for firms. Governments prefer to stabilize the exchange rate because excessive short-term volatility erodes market confidence and affects both the financial market and the real goods market. Central banks generally agree that the primary objective of foreign exchange market intervention is to manage the volatility and/or influence the level of the exchange rate. There are many reasons a country's monetary and/or fiscal authority may want to intervene in the foreign exchange market. The most complete type of currency intervention is the imposition of a fixed exchange rate with respect to some other currency or to a weighted average of some other currencies. The precise objectives are likely to depend on the stage of a country's development, the degree of financial market development and international integration, and the country's overall vulnerability to shocks, among other factors. Policymakers may intervene in foreign exchange markets in order to advance a variety of economic objectives: controlling inflation, maintaining competitiveness, or maintaining financial stability. It occurs when a government or central bank buys or sells foreign currency in exchange for its own domestic currency, generally with the intention of influencing the exchange rate and trade policy. US lawmakers discussing the Currency Harmonization Initiative Through Neutralizing Action (CHINA) Act of 2005Ĭurrency intervention, also known as foreign exchange market intervention or currency manipulation, is a monetary policy operation.
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