1. How do central banks intervene in currency markets in order to maintain a weaker value...
1. How do central banks intervene in currency markets in order to maintain a weaker value for its currency?
2. How can central banks intervene in currency markets in order to maintain a stronger value for its currency?
Homework Answers
1) To weaken the currency, that is to depreciate the currency, the central bank uses the foreign exchange reserves it has accumulated and starts selling domestic currency and buying foreign currencies against it. This releases domestic currency in the market, which increases its supply. As supply increases, the price of currency in terms of the other, the exchange rate falls and the currency is weakened.
2) To strengthen the currency, that is to appreciate the currency, the central bank uses the foreign exchange reserves and starts buying domestic currency and selling foreign currencies against it. This takes away domestic currency from the market, which decreases its supply. As supply decreases, the price of currency in terms of the other, the exchange rate, rises and the currency is strengthened.
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