A monetary policy tool in which a central bank takes an active participatory role in influencing the monetary funds transfer rate of the national currency. Central banks, especially those in developing countries, intervene in the foreign exchange market in order to build reserves, stabilize the exchange rate and to correct misalignments. The success of foreign exchange intervention depends on how the central bank sterilizes the impact of its interventions, as well as general macroeconomic policies set by the government.
|||Two difficulties that central banks face is determining the timing and amount of intervention, as this is often a judgment call rather than a cold, hard fact. The amount of reserves, the type of economic trouble facing the country and the ever changing market conditions makes taking the best course of action difficult.
Foreign exchange interventions can be risky in that they can undermine a central bank's credibility if it fails to maintain stability. Defending the national currency from speculation was a pcipitating cause of the 1994 currency crisis in Mexico, and was a leading factor in the Asian financial crisis of 1997.