A central bank’s interventions in the foreign exchange market have two main objectives: managing volatility and influencing the exchange rate. Both governments and central banks have varying degrees of success, but they often share the common objective of stabilizing a currency’s value against other currencies. Moreover, excessive volatility affects both the financial and real goods markets. A successful FX intervention raises the value of a currency by two percentage points against a major currency, thereby boosting its purchasing power.
Buying and selling currencies
The most popular form of central bank intervention is buying and selling currencies. In this method, the central bank sells currency without actually affecting its value. This approach pushes the central lender to raise interest rates, which hurt the economy. A failed attempt could lead to corrective interventions. Therefore, it is important for the central bank to carefully consider the impact of each intervention. While monetary policy is an important aspect of global economics, there are many risks associated with FX interventions.
In a recent example
The Turkish central bank intervened in the FX market by selling five billion U.S. dollars in December 2021. This was done in relation to the value of the Turkish lira. This intervention was carried out during a period when Turkey’s domestic currency depreciated steadily. Although central banks have limited power in the forex market, they should avoid acting against a trend.