Central Banks and Exchange Rates
Why do Central Banks Care About Exchange Rates?
Written by J. Mance Gordon
Updated at April 23rd, 2024
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Why do Central Banks Care About Exchange Rates?
A central bank will be concerned about the exchange rate for multiple reasons: (1) Movements in the exchange rate will affect the quantity of aggregate demand in an economy; (2) frequent substantial fluctuations in the exchange rate can disrupt international trade and cause problems in a nation’s banking system–this may contribute to an unsustainable balance of trade and large inflows of international financial capital, which can set up the economy for a deep recession if international investors decide to move their money to another country. Let’s discuss these scenarios in turn.
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