Question

What is the extent of intervention by the central bank under a fixed exchange rate system?

Answer 1

In a system with a fixed exchange rate, the central bank is responsible for maintaining this equilibrium. The central bank may intervene in the private foreign exchange (Forex) market by purchasing and disposing of currency of last resort as required.

Answer 2

Under a fixed exchange rate system, the central bank intervenes regularly and actively in the foreign exchange market to maintain the exchange rate at a predetermined level.

• The central bank buys or sells foreign currency as needed to prevent the rate from fluctuating beyond a narrow band.
• If the exchange rate tends to fall below the fixed rate, the central bank buys its own currency using foreign reserves.
• If the exchange rate tends to rise above the fixed rate, the central bank sells its own currency.

This active intervention ensures stability in the exchange rate and promotes certainty in international trade.