Changes In Foreign Exchange Reserves

The changes in foreign exchange reserves take place as and when the central bank implements monetary policy. Upon implementing a fixed exchange rate policy, the central bank might come across a situation where supply and demand would try to push the currency value to a lower or a higher level. The currency value would be higher in case there is an increase in its demand and vice versa.

The changes in forex reserves are very common in a flexible exchange rate regime. The fluctuations in currency values occur automatically in regards to the central bank with the clearance of any of the excess demand or supply by buying or selling the foreign currency. The mixed exchange rate regimes may require the use of foreign exchange operations to maintain the targeted exchange rate within the prescribed limits. However, USA has accused China of following this practice since.

The foreign exchange reserves changes also happen because some of its unsterilized operations result in an expansion or contraction in the domestic currency amount which is currently in circulation, and therefore having a direct affect on the monetary policy and inflation. The forex reserves changes take place as exchange rate target cannot remain unaffected by a inflation target. The nations which do not target a specific exchange rate are believed follow the floating exchange rate, and thus providing markets the ability to set the exchange rate; the nations where there is floating exchange rates followed, some other instruments of monetary policy are commonly given the preference and they may limit the type and amount of foreign exchange interventions. In this case, even those central banks which limit the forex interventions, however, usually find out that the currency markets can be volatile and there may be changes in foreign exchange reserves which can intervene to counter disruptive short-term movements.

In real world, the practice which is followed is such that some of the central banks or currency regimes works on very simplistic level, and there are so many other factors such as domestic demand, production and productivity, imports and exports, relative prices of goods and services, and so on which have an impact on the eventual outcome. The certain effects such as the inflation can take a long time to become apparent, whereas the changes in foreign reserves and currency values in the short term might be huge because of the fact that various markets react to imperfect data.