Answer to Question #254202 in Macroeconomics for Hansi

Question

What are the economic implications of the policy decision of the Central Bank? If 

the Central Bank did not intervene in purchasing foreign exchange, what would 

have been the result?

Answer 1

In order to stimulate the economy or maintain a targeted foreign exchange rate, central banks typically agree that intervention is required. If the local currency appreciates to a level that makes domestic exports more expensive to foreign countries, central banks will frequently buy foreign currency and sell local currency. In order to decrease the expansion of the money supply and reduce inflation, a contractionary monetary policy raises interest rates. This can stifle economic growth and even raise unemployment, but it is frequently justified as required to chill the economy and keep prices in check.If the central bank's current refusal to sell foreign exchange suggests future monetary growth, the home currency will devalue instantly, even if the intervention is not entirely sterilized and the money supply has changed in the current period.