Can Central Banks Still Influence Exchange Rates?

LONDON – On September 16, 1992, a date that lives in infamy in the United Kingdom as “Black Wednesday,” the Bank of England abandoned its efforts to keep the British pound within its permitted band in the European exchange-rate mechanism. Supporting sterling at the required exchange rate had proved prohibitively expensive for the Bank and the British government. By contrast, it proved highly remunerative for George Soros. 

Since then, the Bank of England has eschewed all forms of intervention in the foreign-exchange markets. And the episode served to reinforce an international consensus that countries’ monetary policy should focus on domestic price stability while letting exchange rates float freely.

After Black Wednesday, it became conventional wisdom that it was simply impossible to fix both the exchange rate and domestic monetary conditions at the same time. According to this view, in a market economy with a convertible currency and free capital flows, the exchange rate cannot be manipulated without consequent adjustments to other dimensions of monetary conditions. Seeking to influence exchange rates using capital controls or direct intervention in currency markets was doomed to failure in anything other than the shortest term.

This consensus has been maintained through a long period in which exchange rates between the major Western currencies have been allowed to find their own level. But it did not extend to Asia.