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Exchange rate intervention


With respect to monetary policy's role in manipulating the value of the exchange rate it is worth noting the following comment from the RBA:


'…….the exchange rate has not served as either a target or an instrument of monetary policy in Australia since the currency was floated. The exchange rate is best considered as part of the transmission mechanism….  

      Source:  www.rba.gov.au/MarketOperations


Accordingly, unlike inflation, the RBA does not target a particular level for the value of the AUD.  However, it will occasionally intervene in the foreign exchange market if it believes that that the AUD has clearly overshot (e.g. if the AUD was rising too much, pushed along by speculation, when its underlying value was lower).  Similarly, the RBA may intervene to smooth out persistent volatility in the currency.  


To manipulate the value of the AUD, the RBA directly enters the foreign exchange market and either buys or sells AUD in exchange for another currency (typically the USD).  When it purchases (demands) the AUD, it increases its value and when it sells (supplies) the AUD it decreases its value.  


Sterilised  intervention


Given that domestic banks operate in foreign exchange markets via their purchases and sales of foreign currency, any RBA intervention has implications for liquidity in the cash market and monetary policy more generally.  


If the RBA seeks to increase the value of the AUD, it purchases AUD from domestic banks with its stock of foreign currency.  This draws cash (AUD) out of the cash market and places upward pressure on the cash rate, moving it above the target cash rate.  If the RBA were to allow the cash rate to remain above the target it is effectively the same as tightening monetary policy.  To prevent this from happening, the RBA must restore liquidity in the cash market via open market operations (in this case purchasing securities).  When the RBA totally offsets the impact on liquidity it is referred to as sterilised intervention.  


Conversely, if the RBA sought to prevent the AUD from rising too much it would purchase foreign currency (i.e. sell AUD), driving up the price of foreign currency and reducing the value of the AUD.  This works to increase liquidity in the cash market because banks end up with a greater volume of AUD (which eventually finds its way into the cash market), which then forces the cash rate below the target cash rate.  To sterilise this intervention the RBA must reduce liquidity back to its former level by selling securities.


Overall, since the floating of the Australian currency in 1983, the RBA has, on balance, not systematically changed the value of the currency.  In other words, the purchases and sales of the AUD since 1983 have tended to cancel each other out such that the RBA has neither been a net purchaser or net seller of the currency since 1983.  During the recent growth in the value of the AUD, to well above parity with the USD, the RBA claimed that it did not intervene to restrain the growth in its value.  


The most recent monetary policy easing in late 2013 was seen by some to represent an attempt by the RBA to reduce the value of the AUD  and therefore assist businesses in the tradables sector.  While it is true that lower interest rates will indeed help to reduce the value of the AUD  (because Australian interest rates become 'relatively' lower than overseas rates which reduces capital inflow and encourages capital outflow), the RBA made it clear that the policy decision was designed to boost AD and encourage sustainable growth - not reduce the value of AUD.  


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