Contribution Of Central Banks In The Foreign Exchange Market

  • June 7, 2021
  • Jennifer Moore
Contribution Of Central Banks In The Foreign Exchange Market

Central banks happen to be government agencies that help regulate the national currencies for maintaining a healthy economic framework, maintain imports and exports, stimulate growth and prevent inflation in their economy. They possess a direct impact on financial markets, particularly, the foreign exchange market. The Central Bank happens to be responsible for maintaining their regional economic affairs, hence staying competitive within the worldwide environment.

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As significant players in the forex market, generally, Central banks intervene to restrict rapid and excessively large revolutions in their currency value. It makes sure that the latter are neither overvalued or undervalued for a significant period. Among the significant procedures of Central Bank intervention, one can incorporate the withdrawal or issuing of liquidity within a massive currency or domestic currency swap over a certain period.

Functions Of Central Banks In The Foreign Exchange Market

Central Banks happen to be essential participants in forex markets. Central banks remain engaged within foreign exchange markets to decrease or increase their currency value as compared to additional currencies. Having a unique place in the foreign exchange market, the role of the Central Bank does not come with a profit motive. The decisions of Central banks concerning monetary policy extremely happen to be influential on the determination of exchange rate.

Indirectly, Central banks affect exchange rates with the help of their decisions about monetary policy. In each nation, it is the central bank that happens to be responsible for carrying out monetary policy apart from additional roles. The primary goals concerning monetary policy signify promoting economic growth and price stability. Generally, the central bank happens to address the problems of the domestic economy by transforming the number of interest rates and money. Hence leading to transformations in the rate of exchange as well.

That said, directly, Central banks can affect the rate of exchange with the help of interventions into a foreign exchange market. They can utilize their domestic and foreign currency reserves to trade foreign currencies. Therefore, directly within the foreign exchange market. Here, in the following section, we sum up the significant functions of the Central Bank:

Fixing Monetary Policies

The primary role of the Central Bank highlights setting monetary policy concerning a particular nation. Monetary policy are the actions of central banks to regulate the currency supply. Central banks generally hold the deposits of currency like a form of asset. Such reserves highlight the country’s viability to spend for its foreign debts, hence contributing to its sovereign credit rating overall. Here, the Central Bank Digital Currency (CBDC) can also be considered as well. It leverages the digitized token or an electronic record to stipulate the virtual version concerning the sovereign currency concerning a particular nation or area.

For instance, the United States dollar, Swiss Franc, Euro, and Japanese yen happen to be some of the most popular currency reserves widely held by sovereign countries. It is the central bank’s responsibility to keep the economy moving in a stable and sustained manner. The integral means by which the Central Bank performs it is with the help of open market transactions and interventions. With the help of such open market transactions, Central banks serve to promote economic growth, thereby attempting to restrict the effects of inflation.

With that being stated, these are the activities leading to a change in the exchange rate by the central bank. There might be times when several countries’ Central banks come together to suffice for liquidity across borders. However, most times, monetary policies concerning the most developed nations associate with the cause and effect encompassing their economy.

Fixing Lending Rates

One of the significant functions of the central bank is facilitating lending in its region or state. Central banks offer the required capital to numerous commercial banks. It is one of those lending arrangements between the commercial banks and the central bank, allowing for effective capital access concerning businesses and individuals.

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The lending arrangement rate is usually known as the discount rate. It happens to be the best rate by the Central Bank. Therefore, from which additional kinds of lending rates happen to calculate. It possesses a direct effect on the fund costs to the end borrower. Such loans from the Central Bank to commercial banks assist in ensuring that the system of Banking possesses the required liquidity concerning ongoing credit relationships within the citizens and the commercial banks.

The central bank comes with the responsibility of stabilizing the economy in the respective Nations. They are likely to decrease the interest rates when it comes to stimulating the economy. On the other hand, they can also increase the interest rates for addressing the concerns related to inflation.

Winding Up

As we have mentioned in the above article, Central banks happen to play an essential role in the economic health of their respective nations. They possess various roles incorporating the fixation of lending rates, and fixing monetary policies, ensuring competitiveness worldwide. Playing a pivotal part in managing inflation, interest rates, and overall currency supply, the role of Central banks is widespread.

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