Currency Wars: “Beggar Thy Neighbor” Policy
February 12, 2025
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Central Banks do not intervene often in the Forex market. In fact, the intervention by Central Banks can be considered to be a sign of significant economic weakness in a currency. As a result, Central Bank intervention usually only happens when the currency is under some sort of crisis. This could be a genuine economic crisis like the 2008 crisis or the Euro crisis. Alternatively, it could also be a speculative attack that a country is facing.
There are multiple ways in which Central Banks can intervene in the markets. Some of these ways require more commitment than the others and are also more effective than the others. In this article, we have listed down the 4 prominent types of Central Bank interventions.
The traders and other participants in the market are aware of the monetary might of the Central Banks and therefore more often than not, the currency range declared by the Central Bank becomes the range in which the currency automatically starts trading without any Central Bank intervention.
Jawboning is essentially a technique where the threat of a Central Bank intervention to reset the rates is used to reset the rates without the intervention ever taking place! Jawboning is particularly effective when Central Banks have the reputation for periodic intervention into the open markets.
Concerted intervention only takes place when many Central Banks share the same objective i.e. they want to control a particular exchange rate. Usually jawboning from all Central Banks gets the desired results. One or two Central Banks may actually have to intervene. However, only in the rarest of the rare cases do multiple Central Banks have to conduct operational interventions to correct a currency rate.
Let’s understand this with the help of an example. Let’s say that the Fed is concerned about the dollar depreciation against the Indian rupee and wants to take action to change this. In this case, the Fed will sell Indian rupee in the market and buy dollars from it. This will lead to two effects. Firstly, it will increase the supply of the rupee and secondly it will decrease the supply of the dollars. The objective of the Fed in the Forex market will be fulfilled.
However, there is also a side effect to this policy. The number of dollars in the United States economy would suddenly increase as a result of this transaction. This could cause inflation and other economic issues as well. Therefore, to counter the situation, the Fed would sell United States denominated bonds in the market. As a result, it will remove dollars from the domestic market (sterilizing the effect). The dollars will now be replaced with the government obligation and therefore the inflation and other effects will be controlled.
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