Why do governments intervene in the foreign exchange?
Why do governments intervene in the foreign exchange market by buying and selling
currencies?
Answer:
The main reason is to increase exports. Everytime a currency loses value, goods produced in that country become cheaper for the destination market. As an example, consider a case in which a US dollar bought 3$ pesos of any Latin American country.
$3 pesos thus allow you to buy, say, one CD and import it into America.
However, a devaluation occurs in which the same 1 dollar bill now buys $6 pesos. So, you are now able to buy 2 CDs when previously you bought only 1.
(This is what George Bush has been criticizing the Chinese for, arguing that the yuan is so undervalued, thus flooding American markets with cheap imports).
The most direct consequence of devaluating a currency is inflation.
Currency depreciation makes imports more expensive and, thus, may cause domestic
inflation; thus, a government may intervene to strengthen the currency. Conversely, as
in the previous question, an appreciation may reduce exports and increase imports,
worsening the balance of trade and possibly causing unemployment and loss of GDP, so
a government may intervene to weaken the currency.
Wise move by the Chinese of China.
Indeed very wise, Thumbs up for her people.
Some countries have set up fixed exchange rate regimes to influence trade policy.
In this case; these countries HAVE to intervene in foreign exchange markets: setting up this fixed peg means that their central bank has to hold sufficient reserves to protect against speculative attacks.
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currencies?
Answer:
The main reason is to increase exports. Everytime a currency loses value, goods produced in that country become cheaper for the destination market. As an example, consider a case in which a US dollar bought 3$ pesos of any Latin American country.
$3 pesos thus allow you to buy, say, one CD and import it into America.
However, a devaluation occurs in which the same 1 dollar bill now buys $6 pesos. So, you are now able to buy 2 CDs when previously you bought only 1.
(This is what George Bush has been criticizing the Chinese for, arguing that the yuan is so undervalued, thus flooding American markets with cheap imports).
The most direct consequence of devaluating a currency is inflation.
Currency depreciation makes imports more expensive and, thus, may cause domestic
inflation; thus, a government may intervene to strengthen the currency. Conversely, as
in the previous question, an appreciation may reduce exports and increase imports,
worsening the balance of trade and possibly causing unemployment and loss of GDP, so
a government may intervene to weaken the currency.
Wise move by the Chinese of China.
Indeed very wise, Thumbs up for her people.
Some countries have set up fixed exchange rate regimes to influence trade policy.
In this case; these countries HAVE to intervene in foreign exchange markets: setting up this fixed peg means that their central bank has to hold sufficient reserves to protect against speculative attacks.
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