Question

If a government wanted to reduce the value of its currency relative to the dollar,

a. How could it use direct FX intervention to do so?

b. How could it use indirect FX intervention to do so?

c. How could it use sterilized intervention to do so?

Answer 1

A) If a government wants to reduce the value of its currency using direct FX intervention, then the government should sell its currency. This lead to increase in the supply of the the domestic currency and reduce in the value of domestic currency relative to dollar.

B) If a government uses indirect FX intervention, then the government may reduce tariffs and increase the supply of money in the market leading to reduce in the value of currency rrlative to dollar.

C) sterilized intervention involves purchase or sale of securities without changing the monetary base. In order to reduce the value of currency relative to dollar, the government should buy dollar denominated bonds, increasing the supply of domestic currency. After this in order to maintain the monetary base the government will sell domestic currency bond to sterilize the buy of dollar denominated bond. If this is not sterlized it leads to reduce in the value of domestic currency relative to dollars.