Currency exchange and valuation - FX regimes and central ban...

Learning Outcomes

This article explains how currency exchange rate regimes and central bank intervention affect valuation and crisis risk in an exam context, including:

• Differentiating fixed, soft‑peg/managed, and freely floating FX regimes, with emphasis on how each constrains monetary policy autonomy and exchange rate flexibility.
• Describing the main objectives, channels, and instruments of central bank FX intervention, including reserve operations, policy signaling, and coordination with interest‑rate policy.
• Distinguishing sterilized from unsterilized intervention and linking each to changes in money supply, interest rates, and inflation behavior.
• Evaluating the short‑ and long‑term effectiveness of intervention and capital controls, focusing on reserve adequacy, market credibility, and potential distortions.
• Identifying typical forms of capital controls and regulatory measures that influence cross‑border flows and their use in defending FX regimes.
• Recognizing quantitative and qualitative warning indicators of an impending currency crisis and relating them to regime sustainability.
• Assessing the macroeconomic and portfolio‑level implications of different FX regimes and intervention strategies for growth, trade competitiveness, asset pricing, and currency risk management.

CFA Level 2 Syllabus

For the CFA Level 2 exam, you are required to understand the mechanisms through which currency values are influenced by FX regime choice and central bank actions, with a focus on the following syllabus points:

• Describe different currency exchange rate regimes: fixed, floating, and managed.
• Explain the objectives and tools of central bank intervention in currency markets.
• Assess the effectiveness of capital controls and government/central bank intervention.
• Identify warning signs of a currency crisis.
• Evaluate the macroeconomic and investment implications of FX regime choices.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

Consider the following scenario for the emerging economy of Lydora:

• Lydora pegs its currency (LYD) to the USD at 4.00 LYD/USD within a narrow band of ±1%.
• Capital flows have been strong due to high real interest rates, leading to rapid reserve accumulation and double‑digit credit growth.
• The central bank frequently buys USD and sells LYD, and then conducts open‑market operations in domestic government bonds.
• Recently, the current account has moved into deficit, inflation has risen, and foreign exchange reserves have started to fall.
• The government has proposed a tax on short‑term foreign portfolio inflows and limits on resident purchases of foreign assets.

1. Which description best characterizes Lydora’s exchange rate regime?
   1. Hard peg with no fluctuation band
   2. Conventional fixed peg with narrow band (soft peg)
   3. Freely floating exchange rate
   4. Independently floating with no intervention
2. The combination of buying USD/selling LYD and then conducting offsetting open‑market operations in domestic bonds is best described as:
   1. Unsterilized intervention that contracts the domestic money supply
   2. Unsterilized intervention that expands the domestic money supply
   3. Sterilized intervention that neutralizes monetary effects
   4. Pure signaling intervention with no balance sheet effect
3. From a policy standpoint, which main objective is most consistent with Lydora’s past FX intervention (buying USD and selling LYD as capital inflows surged)?
   1. Preventing excessive appreciation and preserving export competitiveness
   2. Defending the LYD against depreciation pressure
   3. Reducing inflation by tightening domestic liquidity
   4. Generating capital losses on foreign reserves to discourage inflows
4. The proposed tax on short‑term foreign portfolio inflows and limits on resident foreign asset purchases are best described as:
   1. Measures that will permanently eliminate currency risk for LYD‑based investors
   2. Capital controls that may reduce near‑term volatility but can create market distortions
   3. Prudential bank regulations with no effect on cross‑border capital flows
   4. Structural reforms that increase long‑run growth and remove crisis risk
5. Which combination of indicators would most clearly signal rising risk of a future currency crisis in Lydora?
   1. Falling reserves, overvalued peg, rapid credit growth, and high short‑term external debt
   2. Rising reserves, undervalued currency, and current account surplus
   3. Low inflation, positive terms of trade shock, and shrinking money supply
   4. Gradual real depreciation and stable banking system with ample reserves

Introduction

Currency values are shaped by the type of foreign exchange (FX) regime a country adopts and by the actions of its central bank or government. For investment professionals, understanding FX regimes and intervention policies is critical because shifts can influence asset prices, capital flows, and portfolio risk. CFA candidates must know the structure and implications of different exchange rate systems, the methods central banks employ to influence currency values, and the economic outcomes of these policies.

Key Term: exchange rate regime
An exchange rate regime is the set of rules or practices a country uses to manage its currency's value versus other currencies. Regimes range from strict pegs (where authorities target a specific rate) to free floating systems (where market forces largely determine the rate).

At Level 2, you should be able to link regime choice and intervention to valuation frameworks such as interest rate parity, purchasing power parity, and balance‑of‑payments (BOP) trends. You should also recognize how regime stress and policy missteps can create currency crises that transmit to equity and fixed‑income valuations.

A useful high‑level concept is the so‑called “impossible trinity”: a country cannot simultaneously have a fixed exchange rate, free capital mobility, and fully independent monetary policy. It can at most choose two of the three. This trade‑off underpins much of the analysis of FX regimes and intervention.

Key Term: impossible trinity
The impossible trinity (or trilemma) states that a country cannot simultaneously maintain a fixed exchange rate, free capital movement, and independent monetary policy. It must sacrifice one of these objectives.

Types of Exchange Rate Regimes

Central banks and governments choose from a spectrum of exchange rate regimes. For exam purposes, you should be able to classify a regime and infer its implications for monetary autonomy, reserve requirements, and crisis risk.

• Fixed (Hard Peg): The currency's value is anchored tightly to another single currency or a basket, maintained through official intervention. Examples include currency boards and dollarization.
• Soft Peg/Managed (Crawling or Adjustable Peg): The currency is allowed to fluctuate within defined bands or is adjusted periodically by official policy, sometimes following announced rules.
• Floating (Free Float): Currency value is set primarily by market forces. Official intervention is minimal or absent. Central banks focus on domestic policy goals, such as inflation or employment.

Key Term: hard peg
A hard peg is an FX regime in which the domestic currency is either legally replaced by a foreign currency (dollarization) or backed by a currency board that strictly commits to maintaining a fixed exchange rate, with very limited discretion.

Key Term: soft peg
A soft peg is a fixed or heavily managed exchange rate regime where the authority commits to a target level or band but retains some discretion to adjust the parity or widen/narrow the band.

Within these broad categories, several sub‑regimes are commonly discussed in the curriculum.

• Hard pegs in practice:

  • Currency board arrangements require the monetary authority to hold sufficient foreign reserves to fully back the monetary base, severely limiting discretionary monetary policy.
  • Dollarization (or euroization) replaces the domestic currency outright with a foreign currency, eliminating monetary policy autonomy and seigniorage but often boosting credibility where domestic institutions are weak.

• Soft pegs and crawling systems:

  • Conventional pegs fix the rate to another currency but may allow very small bands (e.g., ±1%).
  • Crawling pegs adjust the central parity at regular intervals, often in line with inflation differentials.
  • Crawling bands allow the currency to move within gradually shifting bands.

Key Term: crawling peg
A crawling peg is an FX regime where a currency’s pegged rate is adjusted frequently—typically in response to inflation differentials or other economic fundamentals—following a pre‑announced or rule‑based path.

• Managed floats and free floats:
  • Under a managed float, authorities allow market forces to set the rate most of the time but retain the option to intervene to smooth volatility or resist perceived misalignments.
  • Under a free float, intervention is rare and usually reserved for extreme disorderly market conditions.

Key Term: managed float
A managed float is a regime where a country primarily lets the market determine its currency’s value but reserves the right to intervene when considered necessary, without committing to a specific level or band.

Key Term: free float
A free float is an exchange rate regime in which the currency’s value is determined by supply and demand in the FX market, with minimal or no routine intervention by the central bank.

Regimes and Monetary Policy Autonomy

The regime choice fundamentally constrains monetary policy:

• Under hard pegs, the domestic interest rate must closely follow that of the anchor currency if capital is mobile. Independent monetary policy is essentially sacrificed to maintain the peg.
• Under soft pegs, there is somewhat more flexibility, but significant independent easing or tightening will quickly show up as pressure on the peg and reserves.
• Under floating regimes, particularly with high capital mobility, monetary policy can focus on domestic objectives. The exchange rate absorbs external shocks through appreciation or depreciation.

In the Mundell–Fleming framework:

• With flexible rates and high capital mobility, expansionary monetary policy tends to depreciate the currency (via lower interest rates and capital outflows), while expansionary fiscal policy tends to appreciate it (via higher interest rates and capital inflows).
• Under fixed rates, attempts at independent monetary policy are quickly countered by FX intervention needed to defend the peg, limiting autonomy.

For valuation, recognizing the regime helps you interpret how interest rate changes, fiscal expansions, or external shocks are likely to affect the exchange rate and, therefore, foreign‑currency returns.

Key Term: capital controls
Capital controls are restrictions imposed by governments or central banks to limit or regulate capital inflows and outflows, often to stabilize the domestic currency or gain some monetary policy autonomy.

Central Bank Intervention

Most central banks intervene in currency markets for the following primary reasons:

• To prevent excessive currency appreciation or depreciation.
• To smooth volatility or maintain a target exchange rate or band.
• To accumulate or deplete foreign exchange reserves.
• To bolster credibility of monetary or inflation‑targeting frameworks.
• To mitigate the macro‑financial effects of large capital inflows or outflows.

The main intervention tool is buying or selling domestic currency using foreign exchange reserves. For example, a central bank wishing to support its currency may sell reserves (e.g., USD) to buy its own currency in FX markets. Conversely, limiting appreciation requires buying foreign assets (e.g., US Treasuries) and selling the domestic currency.

Key Term: FX intervention
FX intervention is direct transaction by a central bank in the currency market to influence its exchange rate, usually through purchases or sales of foreign assets and the domestic currency.

Channels and Instruments of Intervention

Beyond spot FX operations, central banks may use several channels:

• Spot and forward FX transactions: Direct buying/selling of currencies, sometimes also using forwards or swaps to influence expectations along the term structure.
• Policy rate changes: While not FX intervention per se, interest rate moves affect capital flows and thus exchange rates. Often, central banks combine rate moves with FX operations.
• Verbal (or “open mouth”) intervention: Public statements intended to shift expectations about future policy or acceptable currency levels.
• Macroprudential and regulatory measures: Limits on FX borrowing, open positions, or maturity mismatches in the banking system that indirectly affect currency demand.

Because developed‑market FX markets are deep and liquid, the size of intervention relative to daily turnover matters. In large markets (e.g., USD, EUR, JPY), direct FX trades by a single central bank often have limited and short‑lived impact unless accompanied by strong policy signals or coordinated action.

Objectives and Strategies of Intervention

• Maintain stability: Prevent sharp, disruptive moves in the exchange rate that could destabilize the banking system or corporate balance sheets, especially when liabilities are denominated in foreign currency.
• Support monetary policy: Pegging or managing the exchange rate can anchor inflation expectations, particularly in economies with weak monetary policy credibility.
• Protect external balance: Prevent sustained currency misalignments that may trigger large trade imbalances or capital flight.
• Control capital flows: Curb destabilizing short‑term foreign investments or sudden stops in funding.

Approaches include:

• Unsterilized intervention: Central bank FX operations that affect the domestic money supply and thus influence interest rates or inflation.
• Sterilized intervention: FX purchases/sales that are offset by open‑market operations to neutralize effects on domestic liquidity.

Key Term: unsterilized intervention
Unsterilized intervention occurs when a central bank’s FX transactions are not offset by domestic open‑market operations, so the intervention directly changes the domestic monetary base and typically affects interest rates.

Key Term: sterilized intervention
Sterilized intervention occurs when a central bank offsets the impact of FX operations on the domestic money supply—typically by buying or selling domestic government securities—so that short‑term interest rates and liquidity are largely unchanged.

Mechanically, consider a central bank defending its currency:

• To support the domestic currency (reduce depreciation), it sells foreign reserves and buys domestic currency. If unsterilized, this withdraws domestic liquidity and tends to raise interest rates, which may attract some capital back and further support the currency, but it can also tighten credit conditions and dampen growth.
• To resist appreciation, it buys foreign reserves and sells domestic currency. If unsterilized, this expands the money supply, lowers interest rates, and may fuel credit growth and inflation if sustained.

With sterilization, the central bank conducts offsetting bond operations so that the net change in the monetary base is close to zero. In theory, sterilized intervention influences the exchange rate mainly via:

• A portfolio‑balance channel, by altering the supply of domestic versus foreign assets available to the private sector.
• A signaling channel, by conveying information about future policy intentions (e.g., a desire to keep the currency within a certain range).

Worked Example 1.1

A country's central bank notices a sharp depreciation of its currency following capital outflows. It sells $2 billion in US Treasury holdings and uses the proceeds to buy back its own currency on FX markets.

Answer:
By selling foreign reserves and buying its own currency, the central bank increases demand for its currency, attempting to slow or reverse the depreciation. If the intervention is unsterilized, domestic liquidity falls because the central bank has absorbed local currency in exchange for foreign assets. This contraction in the monetary base tends to raise short‑term interest rates, which may attract some capital back and further support the currency, but it can also tighten credit conditions and dampen growth.

If the central bank instead sterilizes the operation by injecting liquidity (e.g., purchasing domestic government bonds), the money supply and interest rates change little. In that case, any exchange rate impact must come mainly from signaling or from the altered composition of assets held by the private sector.

Worked Example 1.2

A central bank faces persistent appreciation pressure due to strong capital inflows. It buys $10 billion in foreign assets, issuing domestic base money. To prevent an excessive fall in domestic interest rates, it simultaneously sells $10 billion of domestic government securities from its portfolio.

Answer:
The purchase of foreign assets and sale of domestic currency would, in isolation, expand the monetary base and lower interest rates. By selling domestic securities, the central bank withdraws liquidity, offsetting the monetary impact. Net domestic liquidity is roughly unchanged, so policy rates remain close to target. This is sterilized intervention aimed at limiting appreciation without loosening monetary policy. However, the central bank’s balance sheet becomes more exposed to exchange rate and interest rate risk, and over time sterilization can carry quasi‑fiscal costs if domestic interest rates exceed the yield on foreign reserves.

Exam Warning

Central banks can lose significant reserves trying to defend a peg if market pressures are overwhelming. In a true fixed or hard peg system, currency crises can occur if the peg becomes unsustainable and the central bank exhausts its reserves or loses market credibility. For valuation questions, this often shows up as a discrete devaluation or abandonment of the peg, with large FX losses for unhedged investors.

Effectiveness and Limitations of Intervention

• Short‑term effectiveness: In liquid FX markets, intervention can moderately affect exchange rates in the near term, especially when:

  • It is coordinated across major central banks.
  • It is consistent with the direction of key fundamentals.
  • It reinforces a clear policy signal, such as a shift in the interest‑rate path.

• Long‑term effectiveness: Over time, fundamentals (e.g., relative inflation, productivity growth, current account balances, and long‑run monetary policy) dominate. Persistent intervention against fundamentals can:

  • Deplete reserves in the case of defending an overvalued currency.
  • Lead to excessive reserve accumulation, rapid money growth, and potential inflation or asset bubbles in the case of resisting appreciation.

• Moral hazard: Predictable intervention may prompt riskier investor behavior. For example, if markets believe authorities will always defend a band, leveraged carry trades into the high‑yielding currency may proliferate. When the defense ultimately fails, the unwind can be disorderly.

• Coordination limits and market depth:

  • In major currencies, a single central bank’s intervention is small relative to daily FX turnover, limiting its power to move prices for long.
  • In smaller or emerging markets, where central banks can accumulate reserves large relative to local FX turnover, intervention may be more effective—but also more likely to be used as a substitute for structural reforms.

From an exam standpoint, you should be able to judge in a vignette whether a described intervention is likely to be marginally effective (aligned with fundamentals, ample reserves, credible policy) or largely symbolic (limited reserves, inconsistent with fiscal/monetary stance).

Capital Controls and Regulatory Interventions

To stem speculative flows, governments may impose capital controls:

• Transaction taxes on FX trades or on short‑term portfolio flows.
• Limits on FX conversions or foreign asset purchases by residents.
• Unremunerated reserve requirements or mandatory holding periods for foreign investments.
• Dual exchange rate systems (one rate for current account transactions, another for capital account transactions).
• Administrative limits on banks’ net open FX positions or on foreign‑currency borrowing.

Key Term: capital controls
Capital controls are legal measures to restrict or regulate cross‑border movement of capital—through taxes, quotas, approvals, or outright bans—with the aim of stabilizing the currency or preserving monetary policy space.

It is useful to distinguish:

• Controls on inflows (e.g., taxes on short‑term foreign debt or portfolio inflows), often used to:
  • Reduce appreciation pressure.
  • Lengthen the maturity profile of external liabilities.
  • Limit credit booms and asset bubbles fueled by foreign funding.
• Controls on outflows (e.g., ceilings on resident FX transfers), often introduced in crisis situations to:
  • Slow capital flight.
  • Buy time for policy adjustment and restructuring.

Controls can also be classified as:

• Price‑based (taxes, fees, reserve requirements) that change the cost of flows.
• Quantity‑based (limits, quotas, prohibitions) that cap the volume of flows.

These can dampen volatility in the short run but tend to:

• Distort resource allocation and financial intermediation.
• Encourage circumvention and financial innovation to bypass controls.
• Reduce long‑term investment and participation in global capital markets if perceived as permanent or unpredictable.

Evidence in the curriculum suggests:

• For developed markets with deep, liberalized systems, capital controls are rare and often ineffective.
• For emerging markets, well‑designed, temporary, and transparent measures can modestly reduce vulnerabilities to surges in inflows or sudden stops, but they are no substitute for sound fiscal, monetary, and prudential policies.

Worked Example 1.3

A government introduces a 5% tax on short‑term foreign portfolio inflows and requires foreign investors to keep funds in the country for at least one year before repatriation. Domestic banks also face stricter limits on their net open FX positions.

Answer:
The tax and minimum holding period increase the effective cost and reduce the flexibility of short‑term inflows, making “hot money” less attractive. The limits on banks’ FX positions reduce overall vulnerability to a sharp depreciation. In the short term, these capital controls and prudential measures may lower appreciation pressure and reduce the risk of a boom–bust credit cycle. Over time, however, investors may route flows through instruments not covered by the rules (e.g., trade credit, derivatives), and domestic firms may face a higher cost of capital. The controls do not address key drivers of inflows (such as large interest differentials or weak domestic financial supervision), so they are best viewed as a complement—not a substitute—to broader policy adjustments.

Revision Tip

Relying solely on capital controls cannot address a currency’s structural pressures. Interventions are most effective when paired with sound fiscal discipline, credible monetary policy (often with an explicit nominal anchor such as inflation targeting), and robust macroprudential regulation of the financial system.

Warning Signs of a Currency Crisis

Persistent intervention and unsustainable FX regimes frequently precede crises. The curriculum highlights several warning signs observable in macro and financial data:

• Falling foreign exchange reserves:
  Rapid or persistent reserve losses signal that the central bank is selling reserves to defend the currency. When reserves fall below standard adequacy metrics (e.g., months of import cover, short‑term external debt), the peg’s credibility deteriorates.

• Rigid or overvalued pegs diverging from economic fundamentals:
  If domestic inflation persistently exceeds that of trading partners without offsetting nominal depreciation, the real exchange rate appreciates. An overvalued currency undermines export competitiveness and widens current account deficits.

• Deteriorating current account and terms of trade:
  Worsening terms of trade (export prices relative to import prices) reduce foreign currency earnings. Combined with a rising current account deficit, this raises reliance on foreign capital inflows to finance external imbalances.

Key Term: terms of trade
Terms of trade is the ratio of export prices to import prices. A deterioration means a country must export more to pay for a given amount of imports, weakening external balances.

• Surging short‑term external debt and liberalized capital markets:
  Large volumes of short‑term foreign‑currency borrowing by banks, corporates, or the government create rollover risk. In liberalized systems, investors can pull capital out quickly when sentiment turns.

• Rapid money supply growth relative to bank reserves and rising inflation:
  Excessive domestic credit creation, often under a pegged regime, can fuel inflation and asset bubbles. If money supply grows much faster than FX reserves, the system becomes more fragile.

• Currency value above its historical mean or equilibrium estimates:
  A currency that has appreciated sharply relative to historical norms or various equilibrium models (e.g., PPP, fundamental equilibrium exchange rate) may be vulnerable to a sharp correction.

• Banking sector stress or crises:
  Banking crises often precede or coincide with currency crises. FX mismatches (borrowing in foreign currency, lending in domestic currency) increase the damage when depreciation occurs.

Key Term: currency crisis
A currency crisis is a situation in which a country experiences a sharp and typically sudden depreciation or forced devaluation of its currency, often after a period of defending a peg, leading to financial distress and potential contagion.

Investors should monitor:

• The pace and direction of reserve changes.
• The structure and maturity of external liabilities.
• Policy statements about the FX regime and any shifts in communication.
• Market indicators such as sovereign spreads, CDS prices, and implied FX volatility.

In case vignettes, you may be asked to judge whether a set of indicators points to rising crisis probability and how that should influence asset allocation or hedging decisions.

Worked Example 1.4

Country Z maintains a soft peg to the USD. Over the past two years, Z has experienced: (1) a large and rising current account deficit, (2) rapid growth in domestic credit, (3) stable but low FX reserves relative to short‑term external debt, and (4) double‑digit inflation while the peg has been unchanged. Capital markets are fully liberalized.

Answer:
The combination of high inflation with an unchanged peg implies a significant real appreciation and likely overvaluation of the currency. The growing current account deficit and rapid credit growth suggest an unsustainable domestic demand boom financed by foreign capital. Reserves are not increasing despite ongoing deficits, indicating that inflows are being offset by outward flows or that intervention capacity is limited. With fully liberalized capital markets and large short‑term external debt, Country Z is exhibiting multiple classic warning signs of a potential currency crisis. A sudden stop in capital inflows could force a disorderly devaluation and trigger banking sector distress, particularly if banks or corporates are heavily exposed to foreign‑currency debt.

Macroeconomic and Portfolio Implications

For exam questions, you must not only identify regimes and tools but also infer their macro and investment consequences.

Macroeconomic Implications

• Hard pegs:

  • Pros: Lower exchange rate volatility, potential anchor for inflation expectations, especially useful for small open economies with weak institutions.
  • Cons: Loss of monetary policy autonomy; adjustment to shocks occurs via domestic prices and output (often recessions and unemployment), not via exchange rate changes; high vulnerability to speculative attacks if the peg becomes misaligned.

• Floating regimes:

  • Pros: Exchange rate acts as a shock absorber; monetary policy can target domestic objectives; less need for large FX reserves.
  • Cons: Greater nominal exchange rate volatility, which may be problematic for heavily dollarized balance sheets or shallow financial markets.

• Use of capital controls and intervention:

  • May reduce the amplitude of cycles driven by global “push factors” (e.g., changes in global risk appetite or major central bank policies).
  • But prolonged reliance without structural reforms can lead to misallocation of capital, lower productivity growth, and governance issues.

Portfolio‑Level Implications

For global investors:

• Currency risk management:
  In fixed or tightly managed regimes, FX volatility may appear low, encouraging unhedged positions and carry trades. However, crisis episodes often involve large, discrete devaluations (“peso problems”). Under floats, volatility is higher but often more continuous, making hedging strategies easier to calibrate.

• Asset pricing and expected returns:
  Regimes and intervention shape expected exchange rate paths in relation to interest differentials (uncovered interest parity) and inflation differentials (relative PPP). Understanding whether a central bank is likely to tolerate depreciation, defend a band, or move to a more flexible regime is important for FX and local‑currency bond valuation.

• Balance‑of‑payments flows:
  Sustained capital inflows associated with high‑yield currencies can create profitable carry opportunities but also crash risk when flows reverse. Intervention and capital controls affect the timing and likelihood of such reversals.

• Scenario analysis:
  In vignettes, you may be asked to assess how a regime shift (e.g., from peg to float) would affect:

  • Local bond yields (via changes in inflation risk and monetary policy flexibility).
  • Equity valuations (via changes in export competitiveness and discount rates).
  • Optimal hedging ratios for foreign investors.

Recognizing the FX regime and the credibility of intervention policies allows you to interpret macro data more effectively and to anticipate discrete currency events in your investment analysis.

Summary

FX regimes range from hard pegs to free floats, shaping currency valuation, macro adjustment, and financial stability. Central bank intervention—implemented through currency trades, policy signaling, and sometimes capital controls—may influence rates in the short run, but long‑term outcomes are driven by economic fundamentals and policy credibility. The success of intervention depends on consistent macroeconomic policies, sufficient reserves, and clear communication. Excessive reliance on official support, especially under rigid or overvalued pegs, raises the risk of sudden, disruptive currency crises. For investors and CFA candidates, linking regime choice and intervention strategies to expected exchange rate behavior, crisis warning indicators, and portfolio risk is essential.

Key Point Checklist

This article has covered the following key knowledge points:

• Differentiate fixed (hard peg), soft‑peg/managed, and floating exchange rate regimes and understand their trade‑offs for monetary policy autonomy and exchange rate flexibility.
• Outline central bank objectives in FX intervention, including exchange rate stability, inflation control, and management of capital flows.
• Describe main intervention tools (spot and derivative operations, reserve management, signaling, macroprudential measures).
• Understand sterilized vs. unsterilized intervention and their implications for the money supply, interest rates, and inflation.
• Identify when and why capital controls are applied, and distinguish between controls on inflows and outflows and between price‑based and quantity‑based measures.
• Appraise limitations, side effects, and moral‑hazard risks of frequent intervention and capital controls, especially in the context of the impossible trinity.
• Recognize quantitative and qualitative warning indicators of currency crises, such as falling reserves, overvalued pegs, deteriorating current accounts, and rapid credit growth.
• Assess how FX regime choice and intervention strategy affect macroeconomic outcomes, asset prices, and portfolio currency risk management.

Key Terms and Concepts

• exchange rate regime
• impossible trinity
• hard peg
• soft peg
• crawling peg
• managed float
• free float
• capital controls
• FX intervention
• unsterilized intervention
• sterilized intervention
• terms of trade
• currency crisis