Currency intervention (lat. interventio)
What is currency intervention?
Intervention (lat. interventio - intervention) - In economic theory, the term is used to define intervention by Central Banks or other organizations managing the country's financial system in the position of the national currency in the world market.
In other words, currency intervention is the operations of the central bank of issue, which consist in the purchase or sale of their country's currency to maintain its exchange rate. Also, this concept includes targeted operations associated with the purchase and sale of foreign currency, the purpose of which is to limit the dynamics of the currency rate to certain limits of its depreciation or appreciation. The purpose of intervention is to regulate the exchange rate to a specific level.
What is the essence of intervention in the foreign exchange market?
Currency intervention, in fact, is an ordinary purchase or sale of national currency. This purchase/sale is carried out by representatives of the Central Bank of the country in which the currency operates. The most basic and first purpose of currency intervention is solely the interests of the country, namely its economic sphere. It can be said that currency intervention is a kind of lever in the sphere of regulation monetary policy countries.
In this case, there should always be a fall and rise in price, when buying/selling currency. For this purpose, the Central Bank uses certain schemes:
- In order to raise the exchange rate of the national currency, Central Bank officials need to sell as much foreign currency as possible. At the same time, they buy all the national currency. In this way, they can significantly reduce the demand for all foreign currency.
- The exact opposite situation occurs when the exchange rate of the national currency decreases. Simply put, the Central Bank buys as much foreign currency as possible and tries to sell the national currency. In fact, the exchange rate of the foreign currency should go up and the national currency should go down.
What types of central bank interventions are there?
There are several classifications of intervention. The most common is as follows:
- Open
The Central Bank reports the exact amount and time of the transaction.
- Verbal
This way is disinformation. The Central Bank declares its intention to intervene, after which the market goes into motion, volatility increases. However, if there is no intervention, the price quickly returns to its usual value.
- Indirect
The most unpredictable option, because intervention is carried out by commercial banks at the direction of the Central Bank. Traders especially do not like such interventions, because they generate quite rapid price movements and bring nervousness to the trades.
Interventions differ in the number of participants. They are distinguished by:
- Single sided
Such interventions are often ineffective or inefficient, as the desire of one side is not enough to stabilize the currency.
- Joint
Such interventions are considered more serious, as the intention to change the situation in the market is expressed by two Central Banks.
- Multilateral
Such an intervention is a tool that is practically doomed to success. If the parties can reach an agreement, they can easily change the direction of long-term trends. An example of a multilateral intervention is the G7 meeting that decided to support Japan after the 2011 earthquake. In just a few yen exchange rate was lowered by two percent thanks to joint action by the ECB, the U.S. Federal Reserve and the Bank of Japan.
The third classification divides interventions according to direction:
- Intervention against the trend is aimed at returning the rate to its previous level.
- Trend Intervention is aimed at accelerating changes in the exchange rate. Trend Intervention helps to "accelerate" a weak or barely emerging trend.
The main impact interventions occurs through the mass purchase or sale of currency, securities, and other financial assets. The main objective interventions - normalize the state of the country's economy and financial system, stabilize prices, etc.
What are the results of interventions?
Result interventions Most of the time, it is a decrease or increase in the exchange rate, depending on what it was done for. Intervention is considered an extreme measure of influence on the monetary system of the state, so countries resort to it in rare cases where there is no other way out.
It is worth noting that currency interventions are practically not market-based methods. There are certain conditions for the intervention to be successful. One of such conditions is a huge reserve of financial resources of the Central Bank.