ROLE OF CENTRAL BANKS

Despite the size and importance of the foreign exchange market, it remains largely unregulated. There is no international organization that supervises it, not any institution that sets rules.

However, since the advent of the flexible exchange rate system in 1973, governments and central banks occasionally intervene to maintain stability in the FX market.

There is no standard definition of instability or a disorderly market circumstance must be evaluated on a case-by-case basis. Sharp rapid fluctuation of exchange rates and traders’ reluctance to be ready to either buy or sell currencies may be signs of disorderly market. To restore stability, the central banks often work together. However, a country taking a conservative view on intervention would act only in response to unusual circumstances that require immediate action, like political unrest or natural disasters. Most monetary authorities would be less likely to intervene to counteract the fundamental forces that drive FX markets, such as trade pattern, interest rate differentials and capital flows.