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WHAT IS FOREIGN EXCHANGE INTERVENTION?

Definition and the Legal Status of Intervention

Foreign exchange intervention is defined generally as foreign exchange transactions conducted by the monetary authorities with the aim of influencing exchange rates. It is the process by which the monetary authorities attempt to influence market conditions and/or the value of the home currency on the foreign exchange market. Intervention usually aims to promote stability by countering disorderly markets, or in response to special circumstances.

In Japan, the Minister of Finance is legally authorized to conduct intervention as a means to achieve foreign exchange rate stability. In the United States, the Government and Federal Reserve Board (FRB); in Euro Area, the European Central Bank (ECB); in the United Kingdom, the Bank of England (BOE) operates it.

General Ideas of Foreign Exchange Market

Foreign Exchange Market

To invest in other countries or to buy foreign products, firms and individuals may first need to acquire the currency of the country with which they intend to deal with. In addition, exporters may demand to be paid for their goods and services either in their own currency or in U.S. dollars, which are accepted worldwide. The Foreign Exchange Market, or "Forex" market, in which international currencies trades take place, is called foreign exchange market.

Exchange Rate

Each country has a currency in which the prices of goods and services are quoted - the dollar in the United States, the euro in Germany, the pound sterling in Britain, the yen in Japan, etc. Exchange rates play a central role in international trade because they allow us to compare the prices of goods and services produced in different countries. A foreign exchange rate is the relative value between two currencies. In particular, it is the quantity of one currency required to buy or sell one unit of the other currency. The exchange rate can be quoted in 2 ways: as the price of the foreign currency in terms of home currency (direct terms) or as the price of home currency in terms of foreign currency (indirect terms).

Three Exchange Rate Regimes

In theory, there are three exchange rate regimes, namely flexible, intermediate and fixed. Under a flexible currency regime, the external value of a currency is determined more or less by the force of market supply and demand. Because floating exchange rate permitting enough flexibility to adjust fundamental disequilibria under international supervision, it can prevent competitive depreciation. On the other hand, under a fixed exchange rate arrangement, the monetary authority pegs the domestic currency to one or a basket of foreign currencies. Exchange rates between currencies that are set at predetermined levels and do not move in response to changes in supply and demand. The authority has to intervene in the foreign exchange market whenever the prevailing rate deviates from the specific one. Intermmediate exchange rate arrangement has a medium flexibility lying between flexible and fixed.