International Economic

Chapter 1Intervention in the foreign exchange market

1.1Introduction

By studying the financial crises that took place since 1997 in Asia, Russia and South America, it can be found that in many cases, short-term debt crisis was aggravated through the unloading of stocks, bonds and currencies. Countries with the pegged exchange rate system were the first to be hard hit.

In fact that the collapse of the Thai Baht in July 1997 was followed by an unprecedented financial crisis in East Asia. Thai government fixed the exchange rate of Thai Baht to US Dollars at a level of 24.70 Baht to one Dollar and this rate got fixed, not allowed to float in the past 14 years (FRBSF Economic Letter August 7, 1998).

As is known to everyone, Southeast Asian countries exercise a fixed exchange rate system connected to US Dollars. In order to prevent the occurrence of similar financial crisis in Southeast Asia, Asian Central Banks have piled up their reserves into US dollars.

Assistant Secretary, U.S. Treasury, Harry Dexter W...

Campaign poster showing William McKinley holding U...

The Central Bank Of Ireland - Dublin

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According to the article of Asian reserve (The economist 02/08/2003), it is clearly stated that "Governments see their hefty reserves as an insurance against the vicious swings of a globalised economy and against any future crisis on the scale of 1997-98."

1.2Managed Float

Today's international monetary system is described as a managed float. (Arnold 1998, p. 766) defined managed float is "a managed flexible exchange rate system, under which nations now and then intervene to adjust their official reserve holdings to moderate major swings in exchange rates." In other words, central banks engage in foreign exchange interventions in order to influence their countries' exchange rates by buying and selling currencies.

(Misbkin 1997, p.502) described "central bank intervention in the foreign exchange market affects exchange rates is to see the impact on the monetary base...