Government Intervention  in the Foreign Exchange market

 

1. Reserves and Borrowing. If the value of an exchange rate is falling and the government wants to maintain its original value it can use its foreign exchange reserves( e.g. selling its dollars and purchase pounds.)

2. Borrow The government can also borrow foreign currency from abroad to be able to buy sterling

3. Changing interest rates (In UK this is now done by the MPC) higher interest rates will cause hot money flows and increase demand for sterling

4. Deflation,

• Through either tight fiscal or Monetary policy AD can be reduced.
• By decreasing AD consumers will spend less and  purchase less imports and so will supply less pounds. This will increase the value of the ER
• Lower inflation rate will also help as British goods become more competitive. Thus demand for Sterling will rise.

 

However this policy has an obvious side effect because lower AD will cause lower growth and higher unemployment

5. Supply side measure to increase the competitiveness of the econ. This will take along time to have an effect.

UK forced out of Exchange Rate Mechanism

Note Governments often fail in their attempt to influence the exchange Rate. In 1992 the £ was in the ERM but struggled to keep its value against the DM.

In response the government raised interest rates to 15% and bought £ on the foreign currency reserves. However this was insufficient to stop the £ falling. Eventually the govt had to give into market pressures and exit the ERM.

The govt intervention failed because the market felt the governments intervention was not sustainable. Interest rates of 15% were disastrous for an economy already in recession.

This shows limits of governmnets capacities.

 

Essays and Revision Notes on Exchange Rates

Exchange Rates revision notes and essays

Factors influencing exchange rates

Determination of exchange rates in free markets

Effects of Appreciation

Effects of Depreciation

Government Int

Fixed Exchange Rates

International Trade Revision Notes

Globalisation Essays

Exchange Rate Essays

• Effects of a falling Dollar
• Why Dollar keeps falling
• Discuss Policies to Stop the Dollar Falling
• Does Devaluation Cause Inflation?