This paper will discuss the second part of chapter 19, The Exchange Rate Policy and The Central Bank. The main points I will be discussing are sterilized intervention, fixed exchange rate, speculative attack, and dollarization.
Sterilized intervention is when a central bank purchases or sells foreign currency to influence the exchange value without having an effect on the monetary base. It becomes un-sterilized when the monetary base changes. There are two transactions within sterilized intervention. For example, the federal reserves of New York sells 1.34 billion USD in 1.5 billion euros, therefore the Euro reserves are 1.34 billion USD, this is ...view middle of the document...
The article, Investor’s List: Countries with Fixed Currency Exchange Rates compiles a list of countries with a fixed exchange rate. Shalifay says, “On the other hand, they are susceptible to large one-off moves and de-peg risk. Investors in Venezuela experienced this first hand last week when the country devalued its currency by 32%, from 4.3 VEB to 6.3 VEB per USD” (Shalifay).The currency fixing its exchange rate is forced to depreciate its value, creating a problem of having to create more currency and using more of its currency because of the higher fixed rate to 1 USD. The country also has to adapt to the other countries interest-rate policy.
Speculative attack is a crisis where financial participants believe the government will be unable to maintain its fixed exchange rate, so they have to sell the currency, forcing a devaluation of the currency. There are three main causes of a speculative attack. The first involves fiscal policy and politicians getting involved, if investors believed government spending increases inflation the investors will stop believing officials can maintain the fixed exchange rate so they will no longer invest, which could cause serious problems in the economy and government spending. If a country’s banking system isn’t stable, a central bank may be forced to relax monetary policy to avoid a financial crisis. Lastly a speculative attack can also happen at any time, whether the economy is stable or not.
An example of a speculative attack is what occurred with the British pound. George Soros saw that the British government was under pressure with the British pound and that it might depreciate. The Article, 20 years of ‘Black Wednesday’: How George Soros toppled the Bank of England, describes how George Soros took the risk and how he traded the British pound for other currencies in Europe, he speculated and attacked. The bank of England had to do something but interest rates kept falling, there was nothing else they could do, and “The Bank then raised interest rates from 10 to 12 percent, in an attempt to lure investors into buying pounds and stabilizing the currency. A few hours later, the Bank had to announce interest rates of 15 percent.” The British...