Chapter 18 Part 1: Foreign Exchange Intervention and BOP

[@godfreya-k3003]

i have tried to understand the difference between the sterilized and non-sterilized government intervention but your lecture has really made it very simple for me. thanks.

[@zvone4016]

Thank you very cearl and nice explanation. I am just confused about this last part with BOP. If it is a private entities that are trading across the borders why would central bank intervene and pay the rest of 100 billion for them?

[@bentleyuniversityec391mone6]

You're very welcome! Good question. It's not really the central bank paying off the $100 billion. The $100 billion would be needed by private sector actors to make good on the $100 billion deficit. It is the central bank that holds these dollar reserves, so the account would be drawn down. In effect, the country is using previously accumulated dollars to balance out the equation. The dollars are just held by the central bank.

[@zvone4016]

Thank you. One more question. For example in an unsterilized intervention. Which action actually affects exchange rates? Is it an action of selling a domestic currency on the FOREX market, and therefore resulting in an depreciation, or is it when monetary base increases, interest rates are lower and therefore the capital moves abroad leading again to a depreciation of domestic currency ? Or is it both...

[@bentleyuniversityec391mone6]

Both. The initial sale of the domestic currency will work to depreciate the value in the FOREX market. To the extent that doing so represents an expansionary policy, if there are follow-on effects, such as an increase in GDP or an increase in inflation, these will also work, over time, to depreciate the currency in the FOREX market.

[@Frdy12345]

Why is the supply of dollars not shifting when the CB buys or sells dollars?

[@bentleyuniversityec391mone6]

2345, If the intervention is not sterilized, then the buying/selling of dollars by the Fed changes the monetary base, which changes the money supply. For example, if the Fed buys dollars, then the monetary base is reduced. Remember that the money supply formula is Ms=m*MB. Ms is some measure of the money supply (M1 or M2, for example) and m is the multiplier. If the intervention is sterilized, then when the Fed buys dollars, it simultaneously undertakes an open market purchase of bonds, which works to increase MB. Here, the Fed could do a one to one offset and the MB would not change.

[@Frdy12345]

@@bentleyuniversityec391mone6 thanks for the explanation but why does the supply curve doesn’t move in the chart? Fed is increasing or reducing its dollar assets as a result which I thought should affect the quantity of dollars available before and after the intervention.

[@bentleyuniversityec391mone6]

@@Frdy12345 Ah. I see. The Fed is buying dollars for example, so the demand for dollars rises *in the FX market*. That would push up the value of the USD. Note that this effect is distinct from the effect described in my first reply, which works to decrease the money supply. Note that the supply of dollars in the FX market isn't the same as the money supply.

[@Frdy12345]

@@bentleyuniversityec391mone6 thank you. The vertical supply notion is quite different than the other foreign exchange models we see in most textbooks. It tends to be upward sloping. I guess that’s my main confusion.

[@bentleyuniversityec391mone6]

@@Frdy12345 You're very welcome. How Mishkin does the FX market is a bit different.

[@junma583]

thanks