Foreign exchange intervention

Currency intervention, also known as foreign exchange market intervention or currency manipulation is a monetary policy operation. It occurs when a government or central bank buys or sells foreign currency in exchange for their own domestic currency, generally with the intention of influencing the exchange rate and trade policy.

Policymakers may intervene in foreign exchange markets in order to advance a variety of economic objectives: controlling inflation, maintaining competitiveness, or maintaining financial stability. The precise objectives are likely to depend on the stage of a country's development, the degree of financial market development and international integration, and the country's overall vulnerability to shocks, among other factors.

There are many reasons why a country's monetary and/or fiscal authority may want to intervene in the foreign exchange market. Central banks generally agree that the primary objective of foreign exchange market intervention is to manage the volatility and/or influence the level of the exchange rate. Governments prefer to the exchange rate because excessive short-term volatility erodes market confidence and affects both the financial market and the real goods market. When there is inordinate instability, exchange rate uncertainty generates extra costs and reduces profits for firms. As a result, investors are unwilling to make investment in foreign financial assets. Firms are reluctant to engage in international trade. Moreover, the exchange rate fluctuation would spill over into the financial markets. If the exchange rate volatility increases the risk of holding domestic assets, then prices of these assets would also become more volatile. The increased volatility of financial markets would threaten the stability of the financial system and make monetary policy goals more difficult to attain. Therefore, authorities conduct currency intervention. In addition, when economic conditions change or when the market misinterprets economic signals, authorities use foreign exchange intervention to correct exchange rates, in order to avoid overshooting of either direction. Anna Schwartz contended that the central bank can cause the sudden collapse of speculative excess, and that they can limit growth by constricting the money supply.

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