Why Central Bank Intervention Can't Control Exchange Rates

By Sprinkel, Beryl W. | Futures (Cedar Falls, IA), March 1991 | Go to article overview

Why Central Bank Intervention Can't Control Exchange Rates


Sprinkel, Beryl W., Futures (Cedar Falls, IA)


Why central bank intervention can't control exchange rates

Under the gold standard, currency exchange rates -- the price of one money in terms of another -- were constrained to a narrow band, and parities were fixed. Domestic monetary policy was essentially determined by gold flows: As gold flowed into a nation, that was a signal to increase monetary creation and set forces loose to encourage an adjustment in the balance of payments; conversely, gold outflows necessitated a tighter monetary policy.

The gold standard did not prevent recurring recessions and depressions, but so long as major countries stuck by the rule of the game and did not change parities, accelerating long-term inflation did not occur.

The major weakness of the system was the fact that domestic monetary policy was not free to address domestic woes. The major advantage was the flip side: The gold standard did exert discipline and prevented a long-term deterioration in the value of money.

The post-war Bretton Woods system, which lasted until 1973, was also a system of narrowly fixed exchange rates but with adjustable parities. It worked well for many years when capital flows around the world were highly restricted and in relatively small volume. But eventually it came apart as a result of U.S. inflation and the resulting destabilizing speculation against the dollar. When the dollar came under attack with a fixed exchange rate, it was certain the dollar would not be revalued. Speculators had little to lose and much to gain by betting against the dollar.

Since 1973 most of the world has been on a floating exchange rate system with respect to the dollar, albeit often a dirty float as monetary authorities attempted to influence exchange rates directly through intervention in exchange markets. It is important to recognize that the dollar exchange rate against other major currencies is determined in a massive and highly competitive market. Changes in the dollar exchange rate reflect a myriad set of changing demand and supply forces. Probably the most important is changing expectations concerning the supply of dollars vs. the supply of a foreign currency -- in other words, changing expectations concerning domestic monetary policy and inflation vs. foreign monetary policy and inflation. If the price rise in the United States is expected to exceed inflation abroad, then the dollar would almost certainly weaken.

But that is not all. Exchange rates are influenced by other factors, including tariffs and quotas at home and abroad, growth in productivity, relative tax rates and expectations concerning political stability. As these and other factors are changing constantly, the correct exchange rate today will not be the rate that clears the market tomorrow. Although the exact size of the dollar foreign exchange market is unknown, it is estimated that, on a heavy day, volume of transactions can exceed half a trillion dollars.

Because most exercises in coordinated intervention by major central banks around the world involve only several billion dollars over a period of a few days or weeks, the disparity between the size of the market and the size of cumulative intervention raises questions concerning the probability of success in affecting the equilibrium level of the dollar vs. other major currencies. But the problem is not quite that simple. There can be no doubt that dollar intervention accompanied by a change in monetary policy can indeed affect the dollar exchange rate. But so can a similar change in domestic monetary policy alone.

If the United States were to intervene in the foreign exchange market in an attempt to lower the value of the dollar, it would do so by instructing the Federal Reserve of New York to buy foreign currencies, usually the Deutsche mark or Japanese yen. Additions to Federal Reserve assets have the effect of increasing bank reserves and, hence, monetary creation unless offset in the domestic money market by selling an equal amount of Treasury securities. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Why Central Bank Intervention Can't Control Exchange Rates
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.