Foreign Currency
Operations
The Federal Reserve conducts foreign currency operations (i.e. the
buying and selling of dollars in exchange for foreign currency) under the
direction of the FOMC, acting in close and continuous consultation and
cooperation with the U.S. Treasury, which has overall responsibility for
U.S.
international financial policy. The manager of the System Open Market Account at
the Federal Reserve Bank of New York
acts as the agent for both the FOMC and the Treasury in carrying out foreign
currency operations. Since the late 1970s, the U.S. Treasury and the Federal
Reserve have conducted almost all foreign currency operations jointly and
equally.
The purpose of Federal Reserve foreign currency operations has evolved
in response to changes in the international monetary system. The most important
of these changes was the transition in the 1970s from a system of fixed exchange
rates (established in 1944 at an international monetary conference held in
Bretton Woods, New Hampshire) to a system of flexible (or floating) exchange
rates for the dollar in terms of other countries’ currencies. Under the Bretton
Woods Agreements, which created the IMF and the International Bank for
Reconstruction and Development (known informally as the World Bank), foreign
authorities were responsible for intervening in exchange markets to maintain
their countries’ exchange rates within 1 percent of their currencies’ parities
with the U.S. dollar; direct exchange market intervention by U.S. authorities
was extremely limited. Instead,
U.S.
authorities were obliged to buy and sell dollars against gold to maintain the
dollar price of gold near $35 per ounce. After the
United States suspended the gold convertibility of the
dollar in 1971, a regime of flexible exchange rates emerged; in 1973, under
that regime, the United
States
began to intervene in exchange markets on a more significant scale. In 1978, the
regime of flexible exchange rates was codified in an amendment to the IMF’s
Articles of Agreement.
Under flexible exchange rates, the main aim of Federal Reserve foreign
currency operations has been to counter disorderly conditions in exchange
markets through the purchase or sale of foreign currencies (called foreign
exchange intervention operations), primarily in the
New York
market. During some episodes of downward pressure on the foreign exchange value
of the dollar, the Federal Reserve has purchased dollars (sold foreign currency)
and has thereby absorbed some of the selling pressure on the dollar. Similarly,
the Federal Reserve may sell dollars (purchase foreign currency) to counter
upward pressure on the dollar’s foreign exchange value. The Federal Reserve Bank
of New York also executes transactions in the
U.S.
foreign exchange market for foreign monetary authorities, using their funds.
In the early 1980s, the United States
curtailed its official exchange market operations, although it remained ready to
enter the market when necessary to counter disorderly conditions. In 1985,
particularly after September, when representatives of the five major industrial
countries reached the Plaza Agreement on exchange rates, the United States
began to use exchange market intervention as a policy instrument more
frequently. Between 1985 and 1995, the Federal Reserve,sometimes in coordination
with other central banks,intervened to counter dollar movements that were
perceived as excessive. Based on an assessment of past experience with official
intervention and a reluctance to let exchange rate issues be seen as a major
focus of monetary policy, U.S. authorities have intervened only rarely since
1995.
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