Currency Intervention (Chain of Analysis)

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.

Key Notes

• 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.