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Open market operation: The money circulation is affected by buying or selling government securities. As in US when the government wants to increase the money supply it buys the government bills, notes or bonds and when it wants to reduce the money supply it sells them. This is the most widely used method.

Capital reserve requirement: By changing the amount of money as a percentage of deposits that the banks have to deposit to the central bank, the central bank can affect the money supply in the economy.

Discount rate: By affecting the rate at which banks lend each other or the central bank lends to banks for short period, it could affect money supply and interest rate.

The change in money supply changes the interest rate thereby affecting the exchange rate. Here two things happen - Increase in money supply by itself drives down the value of the currency as demand is constant. By this interest rate goes down which would see foreign investment flowing out thereby depreciating the currency and vice versa.

Direct Intervention- The central bank can directly intervene in the foreign exchange market by buying or selling a foreign currency against which it wants to affect its exchange rate. Simple law of demand and supply applies leading to change in exchange rate.

But the problem is that money supply, interest rate and inflation is linked. Say a central bank wants to slow down the economy by increasing interest rate thereby decreasing inflation, but at the same time it wants to depreciate its currency by buying forex. If it buys forex, money would enter the economy and interest rate goes down. This dilemma is generally faced by emerging countries. So maintaining all the objectives is a complicated job.

The economist came up with sterilized intervention where along with buying or selling forex to affect the exchange rate, central bank also buys or sells government bonds to control the money supply. The following figure makes the concept clear-

‘Real world sterilizations have generally been ineffective in achieving any lasting effect upon a county’s currency value. Sterilized FOREX intervention, not only will not affect GNP, but also will not affect the exchange rate. This suggests the impossibility of the FED’s overall objective to lower the dollar value while maintaining interest rates’ (Suranovic, 2005). Also, ‘Central banks in developing countries, wanting to devalue the domestic currency, usually intervene in the foreign exchange market by buying up foreign currency using domestic money—often backing this up with sterilization to counter inflationary 本论文由英语论文网提供整理，提供论文代写，英语论文代写，代写论文，代写英语论文，代写留学生论文，代写英文论文，留学生论文代写相关核心关键词搜索。