INTERVENTION

The Central Bank buys the currency of their country and sells foreign currencies to support the value of their currency. It also sells its currency and buys foreign currency to try and exert downward pressure on the price of its currency.

The transactions in the intervention are small compared to the total volume of trading in the FX market and these actions do not shift the balance of supply and demand immediately. Instead, intervention is used as a device to signal a desired exchange rate movement and affect the behavior of investors in the FX market.

Usually, intervention operations are undertaken in coordination with other central banks. The New York Fed often intervenes in the FX market as an agent for other central banks and international organizations to execute transactions related to flows of international capital.

Some countries have special arrangements with other countries to help them keep their currencies stable. Many less developed countries have their soft currencies pegged to hard currencies, so their value rises and falls simultaneously with the stronger currency. Some peg, or target, their currency to a basket of hard currencies, the average of a group of selected currencies.

Countries that are part of the European Union had pegged their currencies to the euro. There were formulas set for converting from the euro to the currency of each member nation. However, since January 2002, all currencies that were part of the Economic and Monetary System of the EU ceased to exist.

Intervention in the FX market is not the only way monetary authorities can affect the value of their countries’ currencies. Central banks can also affect foreign exchange rates indirectly by influencing interest rates. If the interest rates in Europe were 5% and in U.S. were 3% then demand for Euro will increase.