Who is responsible for foreign exchange?

The Role of Central Banks in Foreign Exchange Management

Central banks play a pivotal role in managing foreign exchange, which involves the exchange of currencies between different countries. They are responsible for overseeing the value of their national currencies and setting exchange rates in global markets.

Exchange Rate Regimes

Central banks employ various exchange rate regimes to control the value of their currencies:

• Floating Exchange Rate: The currency’s value is determined solely by market forces, without intervention from the central bank. This regime allows for flexibility in response to economic changes.
• Fixed Exchange Rate: The currency’s value is fixed against a particular currency or basket of currencies. This regime provides stability but limits the flexibility of the central bank to respond to economic shocks.
• Pegged Exchange Rate: The currency’s value is pegged to another currency, typically a stronger one. This regime aims to maintain stability while allowing for some flexibility.

Impact on International Trade and Economic Stability

The exchange rate regime chosen by a central bank has significant implications for international trade and economic stability:

• International Trade: Exchange rates affect the competitiveness of a country’s exports and imports. A weaker currency makes exports cheaper and imports more expensive, promoting economic growth. Conversely, a stronger currency has the opposite effect.
• Economic Stability: Stable exchange rates reduce uncertainty and facilitate international trade and investment. They also help prevent inflation and deflation by stabilizing the price of imported goods. However, fixed exchange rates can be risky in the face of economic shocks.

Conclusion

Central banks bear the responsibility of managing foreign exchange and setting exchange rate regimes. Their decisions directly impact international trade and economic stability. By carefully considering the economic implications of their actions, central banks can foster economic growth and maintain financial stability in both domestic and global markets.