Chapter_17 - Chapter 17: Fixed Exchange Rates and Foreign...

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Chapter 17: Fixed Exchange Rates and Foreign Exchange Intervention Central Bank Intervention and the Money Supply The Central Bank Balance Sheet and the Money Supply The balance sheet of the central bank (CB) is Assets: Liabilities: Domestic Assets (DA CB ) Currency in circulation Foreign assets (FA CB ) Bank Reserves Question: How does the central bank control the country’s MS? Answer: Any central bank purchase of assets automatically results in an increase in the domestic money supply, while any central bank sale of assets automatically causes the money supply to decrease. Foreign Exchange Intervention and the Money Supply How does central bank’s intervention in the foreign exchange market affect MS? Suppose DC is depreciating and the central bank wants to stop DC from depreciating: ECMC61 – Chapter 17 1
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The Balance of Payments and the Money Supply The BOP identity: BOP = – ORT Suppose a country runs a BOP surplus (BOP > 0): Sterilization Sterilization: it refers to the situation in which central bank carries out equal foreign and domestic assets transactions in opposite directions to nullify the impact of their foreign exchange operations on the domestic money supply. When the central bank carries sterilized transactions, the level of MS remains unchanged this would help to maintain price stability. Example: When the country runs a BOP surplus, ORT < 0 the central bank accumulates official reserves (FA CB ): Assests CB Liab CB DA CB MB FA CB ECMC61 – Chapter 17 2
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How the Central Bank Fixes the Exchange Rate? Foreign Exchange Market Equilibrium Under a Fixed Exchange Rate
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Chapter_17 - Chapter 17: Fixed Exchange Rates and Foreign...

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