The main role of any central bank is to act as governor, conducting a monetary policy aimed at ensuring economic and financial stability. The concept of economic stability is quite broad, so let’s focus only on one of its key components, namely, ensuring the stability of the exchange rate of the domestic currency against foreign currencies. No matter how paradoxical it may sound in our century of market economies, where the national currency exchange rate is determined based on the supply-demand ratio, in some cases central banks can also have the authority to influence the monetary funds’ transfer rate of the national currency. This does not mean that they can simply say – Ok, the US dollar’s rate relative to the euro will be now 1.3000.
There’s a special monetary policy tool to regulate the exchange rate dynamics – intervention. Intervention in the foreign exchange market is usually a one-time targeted action when the central bank buys or sells a significant amount of foreign currency in exchange for its own domestic currency. It’s actually a fairly effective tool. In modern conditions, when the world is overwhelmed by the financial crisis, many central banks resort to such actions. Let’s take, for example, the Japanese yen. Traditionally, the Japanese yen has long been seen as one of the main safe-haven currencies. During periods of economic uncertainty, demand for the yen increases, which, naturally, contributes to the growth of its exchange rate. This all seems fine and dandy but, but the economy of Japan is export-oriented, which means that it does not benefit from the expensive domestic currency because it negatively affects the competitive power of national goods. Therefore, intervention in the foreign exchange market is perhaps the only relatively painless way to deal with this problem.
All in all, despite the fact that the currency market has a certain aptitude for self-regulation and inclination to maintain equilibrium, without the external influence it would be unable to function properly. So intervention is more of a necessity rather than a whim of the national governments.
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