Money Market Interventions

Essay from the year 2003 in the subject Business economics - Banking, Stock Exchanges, Insurance, Accounting, grade: 1,5 (A), Oxford Brookes University (Business School), course: Synoptic Essays in International Banking & Finance, 36 entries in the bibliography, language: English, abstract: After the collapse of the Bretton-Woods-System in 1973 ...

Essay from the year 2003 in the subject Business economics - Banking, Stock Exchanges, Insurance, Accounting, grade: 1,5 (A), Oxford Brookes University (Business School), course: Synoptic Essays in International Banking & Finance, language: English, abstract: After the collapse of the Bretton-Woods-System in 1973 and the transition to asystem of floating rates between the major global currencies, central banks still useinterventions for exchange rate maintenance. This paper aims to examine thefunction of Central Bank operations in foreign exchange markets on the basis of twoempirical data sets, explaining both, appreciation and depreciation. It tries to analysethe impacts on capital flows recorded in the balance of payments and the efficiencyof interventions. Further it will analyse the impacts on domestic monetary suppliesand if necessary how to sterilise these effects. At certain stages endnotes will refer tothe appendix for more detailed explanations or data. To illustrate, how central bank interventions work, we will take the European CentralBank (ECB) as an example and concentrate on two currencies, the euro (€) and theUS dollar ($). [...] If the ECB aims at an appreciation of the own currency, the bank will engage in aforeign exchange operation and buy euros against its US dollar reserves. Thedemand for euros increases (demand curve shifts to the right) and simultaneously supply is reduced, because the ECB takes Euro out of the market (supply curveshifts to the left). Through the forces of supply and demand the value of the euro willstrengthen in international markets (the exchange rate moves from r1 to r2).Depreciation (see diagram 2)If the ECB aims at a depreciation of the own currency, the bank will sell euros againstdollars. In this case, demand for euros declines (demand curve shifts to left) and thesupply increases (shift to the right) because the ECB pays the purchased dollars ineuro. Again, the forces of supply and demand determine the new exchange rate at r2.The value of the euro will weaken in international markets (and inversely the USdollar value will rise). [...]