Monthly Archives: May 2016

Central Bank Methods for Managing Currency Valuation

In June of 2015 as Chinese stocks crashed, the Chinese central bank, the People’s Bank of China (PBOC), wrote to the United States Federal Reserve to ask for their advice in mitigating a stock market plunge. (Reuters) The specific advice related to how Greenspan dealt with Black Monday in 1987 including how to inject cash into the market and also provide reassuring messages to the market. China, however, was facing three challenges: it had to maintain a currency peg, support equities and target interest rates on the open market. Two months later the PBOC chose to drastically devalue their currency.

The United States and China differ in the policy options available to their Central Banks for two main reasons. First, the United States is restricted in how much it can devalue its own currency without causing global turmoil. Secondly, the United States Federal Reserve is limited in its trading ability by the Federal Reserve Act. Their actions, however, are similar to the PBOC but require different avenues to remain legal.

The Fed and PBOC are also alike in that they require their currency to be stable. The United States benefits from the Dollar being the primary reserve currency, a position which requires a stable currency at least relative to other major currencies. Likewise, China, who wishes the Renminbi to become a major reserve currency, cannot manipulate their currency openly. Therefore, both are constrained in this aspect. However, in a globalized world of free-floating exchange rates, many policy options remain available.

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