Instrument of Managing Exchange Market Pressure: Money Supply or Interest Rate

Abstract

Exchange market pressure (emp) reflects disequilibrium in money market. The traditional approaches used to examine the disequilibrium in money market include the monetary approach to balance of payments and monetary approach to exchange rate. Under the former approach the variation in foreign reserves helps restore the equilibrium while under the latter one the change in exchange rate does the needful.1 The idea of this study stems from the fact that under the managed float exchange rate regime, changes in foreign reserves or changes in exchange rate in isolation are not a sufficient guide to characterise the external account situation of an economy. For example, exchange rate depreciation can be partially avoided or at least delayed if the central bank injects foreign currency in the forex market by letting its foreign reserves deplete. Alternatively, central bank can build up foreign reserves by purchasing foreign currency from the market against domestic currency. Such intervention would curb the exchange rate appreciation demanded by fundamentals. Therefore, focus on either of the two, that is, movement in exchange rate or variation in foreign reserves, to the complete exclusion of the other, is bound to portray a misleading picture of the external account situation. Given the foregoing a composite variable, that incorporates changes in exchange rate as well as variation in foreign reserves, over a certain period, is needed to characterise the condition of external account. The requisite composite variable has been developed by Girton and Roper (1977) as ‘simple sum of exchange rate depreciation and variation in foreign reserves scaled by monetary base’. They refer to it as exchange market pressure (emp).

Effect of Bank Ownership on the Relationship between Credit Risk and Financial Performance of Commercial Banks in Kenya

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Determinants of short and long-term exchange market pressure in Indonesia

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