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Chapter 9
Foreign Exchange Rate Determination and Intervention
◼ Learning Objectives
1. Explore how the three major approaches to exchange rate determination
2. Detail how and why direct and indirect foreign exchange market intervention is
conducted by central banks
3. Analyze the primary causes of exchange rate disequilibrium in emerging market
currencies
4. Observe how forecasters combine technical analysis with the three major theoretical
approaches to forecasting exchange rates
◼ Chapter Outline
I. Exchange Rate Determination: The Theoretical Thread
Parity Conditions Approach
Balance of Payments Approach
Monetary Approach and Asset Market Approach
Monetary Approach
Asset Market Approach
The Asset Market Approach to Forecasting
II. Currency Market Intervention
Motivations for Currency Market Intervention
Intervention Methods
Direct Intervention
Indirect Intervention
Capital Controls
III. When Foreign Currency Intervention Fails
Turkey 2014
Japan 2010
IV. Disequilibrium: Exchange Rates in Emerging Markets
© 2018 Pearson Education, Inc.
2. PPP Inadequacy. The most widely accepted theory of foreign exchange rate determination
is purchasing power parity, yet it has proven to be quite poor at forecasting future spot
exchange rates. Why?
3. Data and the Balance of Payments Approach. Statistics on a country’s balance of
payments are often used by the business press and business itself often in terms of
predicting exchange rates, but the academic profession is highly critical of it. Why?
4. Supply and Demand. Which of the three major theoretical approaches seems to put the
most weight into arguments on the supply and demand for currency? What is its primary
weakness?
© 2018 Pearson Education, Inc.
5. Asset Market Approach to Forecasting. Explain how the asset market approach can be
used to forecast future spot exchange rates. How does the asset market approach differ
from the balance of payments approach (listed in Exhibit 9.1 and detailed in Chapter 3) to
forecasting?
© 2018 Pearson Education, Inc.
6. Technical Analysis. Explain how technical analysis can be used to forecast future spot
exchange rates.
7. Intervention. What is foreign currency intervention? How is it accomplished?
8. Intervention Motivation. Why do governments and central banks intervene in the foreign
exchange markets? If markets are efficient, why not let them determine the value of a
currency?
© 2018 Pearson Education, Inc.
9. Direct Intervention Usefulness. When is direct intervention likely to be the most
successful? And when is it likely to be the least successful?
10. Intervention Downside. What is the downside of both direct and indirect intervention?
11. Capital Controls. Are capital controls really a method of currency market intervention, or
more of a denial of activity? How does this fit with the concept of the Impossible Trinity
discussed previously in Chapters 2 and 6?
© 2018 Pearson Education, Inc.
12. Asian Crisis of 1997 & Disequilibrium. What was the primary disequilibrium at work in
Asia in 1997 that likely caused the Asian financial crisis? Do you think it could have been
avoided?
13. Fundamental Equilibrium. What is meant by the term “fundamental equilibrium path”
for a currency value? What is “noise”?
© 2018 Pearson Education, Inc.
16. Exchange Rate Dynamics. What is meant by the term “overshooting”? What causes it and
how is it corrected?
17. Foreign Currency Speculation. The emerging market crises of 1997–2002 were worsened
because of rampant speculation. Do speculators cause such crisis or do they simply
respond to market signals of weakness? How can a government manage foreign exchange
speculation?
© 2018 Pearson Education, Inc.
18. Cross-Rate Consistency in Forecasting. Explain the meaning of “cross-rate consistency” as
used by MNEs. How do MNEs use a check of cross-rate consistency in practice?
19. Stabilizing versus Destabilizing Expectations. Define stabilizing and destabilizing
expectations, and describe how they play a role in the long-term determination of
exchange rates.
20. Currency Forecasting Services. Many multinational firms use forecasting services
regularly. If forecasting is essentially “foretelling the future,” and that is theoretically
impossible, why would these firms spend money on these services?
© 2018 Pearson Education, Inc.
