25+Exchange+Rates+and+International+Economic+Policy%2C+Part+2

25+Exchange+Rates+and+International+Economic+Policy%2C+Part+2

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1 25-1 Exchange Rates and International Economic Policy, Part 2 25-2 Agenda 1. Intervention in the Foreign Exchange Market 2. Fixed Exchange Rate Regimes 25-3 Interventions in the FX Market Foreign exchange interventions are international financial transactions engaged in by central banks to influence exchange rates. International reserves are the foreign currency denominated asset holdings on a central bank’s balance sheet. 25-4 Interventions in the FX Market Suppose a central bank: 1. Sells some of its foreign assets holdings in the foreign exchange markets 2. By purchasing its domestic currency.
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2 25-5 Interventions in the FX Market This would lead to: 3. A decline in international reserves held by the central bank, 4. A decline in reserves held by the banking system. 25-6 Interventions in the FX Market The decline in reserves in the banking system then leads to: 5. A decline in the domestic money supply and 6. A rise in the nominal interest rate. 25-7 Interventions in the FX Market i M/P M S /P M D /P i 0 25-8 Interventions in the FX Market In the short-run when prices are sticky, 1. An increase in the nominal interest rate will also cause an increase in the real interest rate. 2. An increase in the real interest rate, r D , will 3. Shift the demand curve for domestic currency denominated assets to the right.
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3 25-9 Interventions in the FX Market E (Euros/$) Q $ S $0 D $0 E 0 25-10 Interventions in the FX Market • An intervention in which the central bank buys domestic currency leads to a loss of international reserves and an appreciation of the domestic currency . • An intervention in which the central bank sells the domestic currency to purchase foreign assets leads to an increase in international reserves and a depreciation of the domestic currency . 25-11 Interventions in the FX Market •In th e U .S
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This note was uploaded on 03/13/2012 for the course ECON 100B taught by Professor Wood during the Fall '08 term at Berkeley.

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25+Exchange+Rates+and+International+Economic+Policy%2C+Part+2

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