Currency Intervention (Chain of Analysis)
- AS, A-Level, IB
- AQA, Edexcel, OCR, IB, Eduqas, WJEC
Last updated 21 Mar 2021
Here is a short revision video exploring a chain of reasoning to this question: Explain two ways in which a central bank can cause a currency depreciation.
- Attempts by a central bank to cause a currency depreciation happens in a managed floating exchange rate system. A depreciation is a drop in the external value.
- One policy is to cut interest rates. This is designed to cause an outflow of hot money from the banking system and an increase in currency flowing overseas seeking a better return.
- Another intervention would be for the Central Bank to go directly into the foreign exchange market and sell your country’s own currency and buy foreign currencies.
- This again leads to an increased market supply of the domestic currency and a fall in the exchange rate. One effect would be a rise in foreign currency reserves.