After the collapse of the Bretton-Woods-System in 1973 and the transition to a
system of floating rates between the major global currencies, central banks still use
interventions for exchange rate maintenance. This paper aims to examine the
function of Central Bank operations in foreign exchange markets on the basis of two
empirical data sets, explaining both, appreciation and depreciation. It tries to analyse
the impacts on capital flows recorded in the balance of payments and the efficiency
of interventions. Further it will analyse the impacts on domestic monetary supplies
and if necessary how to sterilise these effects. At certain stages endnotes will refer to
the appendix for more detailed explanations or data. To illustrate, how central bank interventions work, we will take the European Central
Bank (ECB) as an example and concentrate on two currencies, the euro (€) and the
US dollar ($). [...] If the ECB aims at an appreciation of the own currency, the bank will engage in a
foreign exchange operation and buy euros against its US dollar reserves. The
demand for euros increases (demand curve shifts to the right) and simultaneously supply is reduced, because the ECB takes Euro out of the market (supply curve
shifts to the left). Through the forces of supply and demand the value of the euro will
strengthen 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 against
dollars. In this case, demand for euros declines (demand curve shifts to left) and the
supply increases (shift to the right) because the ECB pays the purchased dollars in
euro. 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 US
dollar value will rise). [...]
Table of Contents
1. Introduction
2. The mechanism of exchange market operations
3. Supporting the exchange rate
3.1 The ECB intervention in September 2000
3.2 Economic effects
- Balance of payments
4. Capping the Exchange rate
4.1 The FED intervention in 1985
4.2 Economic effects
- Balance of payments
5. Efficiency of interventions
6. Monetary impacts of interventions
6.1 Sterilisation of interventions
7. Conclusion
Objectives and Topics
This paper examines the role and effectiveness of central bank interventions in foreign exchange markets, utilizing two distinct historical case studies to illustrate both appreciation and depreciation efforts. The research explores how these operations influence capital flows, domestic monetary supplies, and the overall stability of exchange rates.
- Mechanisms of central bank foreign exchange operations.
- Empirical analysis of the ECB's intervention in 2000.
- Empirical analysis of the FED's intervention in 1985.
- Impact of interventions on the balance of payments.
- Concepts and application of sterilisation policies.
Excerpt from the Book
3. Supporting the exchange rate
The European Central Bank (ECB) made extensive use of interventions in order to support the euro at its all-time low during September 2000. The ECB conducted, beside the sales of US $ on 14th September, a major intervention by selling US $ on 22nd September1. Diagram 3 shows the development of the US $/€ rate in the three day period of 21/22/25th September adjusted to 1.0 at market opening. For comparison the GBP/€ and the Yen/€ rate have been added. Diagram 4 shows intraday data of the intervention with real rates.
A strong reaction of the market participants is recognizable at the time of ECB’s market entry at Frankfurt exchange market (11:00 am). Being named as such by the ECB, the operation was clearly an intervention in order to support the euro. The transaction value was not clearly announced2. The euro value rose from 0.87035 US $ (11:00 am) by 2.74% to 0.8942 US $ (11:20 am). The foreign currency reserves sharply fell from 264,130 billion € in August to 234,233 by end of November (ECB International Reserves, 2000).
Summary of Chapters
1. Introduction: The introduction outlines the shift to floating exchange rates post-Bretton Woods and defines the research goal of analyzing central bank intervention efficiency and monetary impacts.
2. The mechanism of exchange market operations: This section explains the fundamental mechanics of how central banks influence currency values through supply and demand shifts.
3. Supporting the exchange rate: This chapter details the ECB's efforts to prop up the euro in September 2000 and evaluates the subsequent economic effects.
4. Capping the Exchange rate: This chapter analyzes the 1985 FED intervention intended to devalue the US dollar and its impact on the US trade balance.
5. Efficiency of interventions: The section evaluates the success of interventions based on sustainability and impact on market trends.
6. Monetary impacts of interventions: This part examines how foreign exchange operations alter the domestic money supply and how central banks utilize sterilisation to mitigate these effects.
7. Conclusion: The conclusion synthesizes the findings, noting that the primary rationale for modern interventions is often behavioral signaling and the facilitation of open market operations.
Keywords
Central Bank, Foreign Exchange Intervention, Exchange Rate, Appreciation, Depreciation, ECB, FED, Balance of Payments, Sterilisation, Monetary Policy, Money Supply, Market Efficiency, Capital Flows, Euro, US Dollar.
Frequently Asked Questions
What is the fundamental focus of this paper?
The paper examines the function, efficiency, and monetary consequences of central bank interventions in foreign exchange markets, specifically focusing on how these institutions maintain or adjust exchange rates.
What are the primary case studies presented?
The study centers on two major historical examples: the European Central Bank's effort to support the euro in September 2000 and the US Federal Reserve's intervention to devalue the dollar in 1985.
What is the central research question?
The work seeks to determine whether central bank interventions are efficient in sustainably changing market trends and how these operations affect the balance of payments and domestic monetary supply.
What scientific methodology is applied?
The author employs an empirical analysis of two distinct datasets, comparing market reactions, trade balances, and monetary base shifts following specific intervention events.
What topics are covered in the main body?
The main body covers the mechanics of currency support and capping, the economic effects on the balance of payments, criteria for measuring intervention efficiency, and the technical necessity of sterilisation.
Which keywords characterize this research?
Key terms include central bank intervention, exchange rate management, sterilisation, balance of payments, monetary policy, and market efficiency.
How does the ECB's 2000 intervention compare to the 1985 FED action?
The paper suggests that the 1985 FED intervention was more successful in achieving a sustained impact on currency values, whereas the 2000 ECB intervention showed limited long-term effectiveness in reversing market trends.
What role does "sterilisation" play in central bank operations?
Sterilisation is the process used by central banks to neutralize the impact of foreign exchange operations on the domestic money supply by buying or selling short-term assets, thereby keeping the monetary base stable.
- Quote paper
- Markus Bruetsch (Author), Alexander Dalhoff (Author), 2003, Money Market Interventions, Munich, GRIN Verlag, https://www.grin.com/document/14851
