Central Bank Intervention. Foreign exchange intervention: definition, mechanism

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:47

Today, in many countries of the world, a policy of a controlled exchange rate of the national currency is being pursued, for which the state Central Banks carry out so-called foreign exchange interventions, optimized for a certain value of the domestic currency. After all, letting the national currency rate float freely, you can get problems in the economy. What is the currency intervention of the Central Bank, and how it is carried out - this should be understood in more detail.

Definition of intervention

Currency intervention is a one-time transaction for the purchase or sale of foreign currency, carried out in the Russian Federation by the Bank of Russia. At the same time, the volumes of foreign exchange interventions are usually quite large. Their purpose is to regulate the exchange rate of the national currency in the interests of the state. Basically, such actions are implemented in order to strengthen the national currency, but sometimes they can also be aimed at weakening it.

Such transactions can significantly affect both the foreign exchange market as a whole and the exchange rate of a certain monetary unit. Currency interventionsare initiated by the Central Bank of the country and, in general, they are the main method of conducting monetary policy. In addition, the regulation of currency relations, especially when it comes to third world countries, takes place jointly with other members of the IMF. To participate in such events, banks and treasuries are involved, and manipulations are carried out not only with currencies, but also with precious metals, in particular, with gold. Currency intervention of the Central Bank is carried out exclusively by prior agreement and is carried out within specific, predetermined terms.

Mechanisms for increasing and depreciating the national currency

In fact, the mechanism for regulating the exchange rate of the national currency is very simple, and it is built on the basis of the principle of "supply and demand". If it is necessary to increase the cost of domestic money, the Central Bank of the country begins to actively sell foreign banknotes (mainly the dollar), while any other convertible currency can be used. Thus, the intervention of the Central Bank leads to an overabundance (increased supply) of foreign currency in the financial market. At the same time, the Central Bank is buying up the national currency, which creates additional demand for it, which can make the exchange rate grow even faster.

The currency intervention of the Central Bank is carried out in exactly the opposite way, aimed at weakening the exchange rate of the national currency, which is being actively sold, not allowing its value to grow. Buying foreign banknotes leads to theirartificial shortage in the domestic market.

Types of currency interventions

It is noteworthy that the intervention of the Central Bank does not always mean buying and selling a large amount of currency, from time to time a fictitious procedure can be carried out, sometimes it is called verbal. In such cases, the Central Bank starts up some kind of rumor or "duck", as a result of which the situation on the foreign exchange market may noticeably change. Sometimes fictitious intervention is used to enhance the effect of real foreign exchange intervention. Also very often several banks can join forces to achieve the desired result.

Practice shows that verbal intervention is used by Central Banks much more often than real one. Surprise factor plays a big role in such cases. In any case, the intervention of the Central Bank, aimed at strengthening the current trend in the foreign exchange market, is usually more successful than manipulation, the purpose of which is to turn it in the opposite direction.

Currency intervention on the example of Japan

History knows a lot of cases of manipulation in the foreign exchange market. For example, in 2011, due to difficulties in the economies of the United States and the European Union, Japan had to adjust the exchange rate of the national currency, and the country's authorities were forced to reduce it. The Minister of Finance of Japan said that speculation in the foreign exchange market caused the yen to overvalue against foreign banknotes and this state of affairs does not correspond to the state of the country's economy. SubsequentlyIt was decided to adjust the exchange rate of the yen together with the Central Bank of Western countries, for which Japan made several major transactions to buy foreign currency. The introduction of trillions of yen into the foreign exchange market helped to reduce its rate by 2% and balance the economy.

Use of financial leverage in Russia

A vivid example of the use of financial leverage in Russia can be observed since 1995. Until that moment, the Central Bank sold foreign currency to regulate the ruble exchange rate, and in July 1995 the principle of a currency corridor was introduced, according to which the value of the national currency must be maintained within the established limits and for a certain period of time. However, changes in the world economy by 2008 made this model of monetary policy ineffective, after which a dual-currency corridor was introduced. In this case, the exchange rate of the ruble was regulated on the basis of its relation to the dollar and the euro. One way or another, the Central Bank conducts foreign exchange interventions, following this monetary policy.

The events of 2014-2015 affected the fruitfulness of the foreign exchange interventions carried out by the Central Bank of Russia, so its latest manipulations did not give the desired result. The fall in oil prices, the resulting reduction in central bank reserves, and the mismatch of the budget ultimately make foreign exchange intervention irrational and pointless.

An alternative to managed exchange rate

Today, Russia is largely dependent on the export of hydrocarbons, which hinders the growth of the national currency. Therefore, such financial leverage as interventionThe Central Bank, with the help of which the dollar and the euro are systematically poured into the market, is simply necessary for the country's economy. However, in the light of recent events, when the intervention of the Central Bank ceased to help control the value of the national currency, from November 10, 2014, the transition to a floating exchange rate of the ruble was carried out. Now currency interventions are carried out only in exceptional cases.

Perhaps this article provides an exhaustive answer to the question of what is the Central Bank's foreign exchange intervention, so it would be unnecessary to go into the intricacies of financial instruments more thoroughly.