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Federal Reserve monetary policy is one influence on the foreign exchange (FX) value of the dollar.
In conjunction with the U.S. Treasury, the Fed sometimes intervenes in the FX market, though in recent years intervention has become much less frequent.
The Fed provides a variety of services to more than 200 foreign central banks, foreign governments and international official institutions.
As part of its bank supervision responsibility, the Fed conducts annual examinations of most foreign bank branches and agencies operating in the United States.
As the central bank of the United States, the Federal Reserve plays a variety of roles in the international arena. By influencing interest rates, the Fed's monetary policy affects the foreign exchange value of the dollar. Also, when the U.S. monetary authorities decide to intervene in the FX market, it is the Fed that executes the intervention.
Foreign Exchange Rates FX rates are of concern to governments because changes in the rates affect the value of products and financial instruments. As a result, unexpected or large changes can affect the health of nations' markets and financial systems, as well as inflation and economic growth. For example, if the Japanese yen rises in value compared with the dollar, U.S. exports become less expensive for the Japanese to buy; that could lead to an increase in U.S. exports and a boost to U.S. employment. At the same time, the lower value of the dollar compared with the yen could raise U.S. import prices and act as an inflationary influence in the United States.
Interest rate differentials between countries are an important influence on FX rates. Money tends to flow into investments in countries with relatively high real (that is, inflation-adjusted) interest rates, increasing the value of those countries' currencies in the FX market. Thus, the Fed's monetary policy affects the FX value of the dollar.
Foreign Exchange Intervention Although Congress has assigned the U.S. Treasury primary responsibility for international financial policy, the Treasury's FX decisions typically are made in consultation with the Fed. If the monetary authorities elect to intervene in the FX market, the intervention is carried out by the Federal Reserve Bank of New York. To support the dollar's price against another currency, the New York Fed buys dollars and sells the foreign currency; conversely, to reduce the value of the dollar, it sells dollars and buys the foreign currency.
Because the Fed's purchases or sales of dollars are small compared with the total volume of dollar trading, they do not shift the balance of supply and demand immediately. Instead, intervention is used as a device to signal a desired exchange rate movement and it affects the behavior of investors in the FX market.
The foreign currencies used for U.S. FX intervention usually come equally from Federal Reserve holdings and the Exchange Stabilization Fund of the Treasury. U.S. interventions may be coordinated with other central banks, especially the central bank of the country whose currency is involved in the FX transaction.
In recent years, the Fed and the Treasury have made their interventions more transparent. The Treasury Secretary typically confirms U.S. intervention while the Fed is conducting the operation or shortly thereafter. Often, statements that reflect the official U.S. stance on its exchange rate policy accompany the Treasury's confirmation of the intervention.
The Federal Reserve Bank of New York announces full details of the U.S. monetary authorities' FX activities about 45 days after the end of every calendar quarter in a report issued to Congress and simultaneously made public. The frequency of intervention varies; the U.S. monetary authorities intervened in the FX market eight times in 1995, but only twice from mid-August 1995 through December 2007.
Services to Foreign Institutions Foreign official institutions may establish deposit and custody accounts at the New York Fed for the purpose of receiving and making payments in U.S. dollars, and for investing in and holding U.S. dollar-denominated debt securities.
In addition, the New York Fed invests funds on behalf of central banks and international official institutions. The investments may be in overnight repurchase agreements, or U.S. Treasury and agency securities. The Federal Reserve does not give investment advice.
Most of the assets in foreign official accounts at the New York Fed are in the form of marketable U.S. government securities and securities of government-sponsored enterprises (federal agencies).
In addition, the New York Fed provides vault facilities to foreign countries and international official institutions for the deposit and safekeeping of gold. The gold holdings at the New York Fed constitute the world's largest concentration of monetary gold; the U.S. Treasury's depository at Fort Knox, Kentucky, is the second largest.
At the request of a central bank or international official customer, the New York Fed executes transactions in the foreign exchange market for the purchase and sale of non-dollar currencies. The New York Fed acts only as an agent for the customer in these transactions. These transactions are not considered intervention operations by U.S. monetary authorities, nor are any U.S. resources involved.
The Fed also provides other services to foreign central banks and international official institutions. For example, each year the Fed conducts a central banking seminar for central bank representatives. On request, the Fed may also provide onsite technical assistance to central banks in areas such as bank supervision, payment systems and open market operations.
Bank Supervision The Federal Reserve has the primary responsibility for supervising and regulating Edge Act and agreement corporations, through which U.S. banking organizations conduct operations outside the United States. Also, the Foreign Bank Supervision Enhancement Act of 1991 gave the Fed the primary responsibility for examining the U.S. operations of foreign banks, and the Fed generally examines foreign bank branches annually.
The Fed also assesses the parent banks' financial condition to ensure that the banks can support their U.S. branches. If the Fed finds a problem with the U.S. branch of a foreign bank, it can address the matter in a number of ways. In less serious cases, the Fed may take informal action, such as requiring a letter of commitment from the bank that details when and how the problem will be corrected. In the most serious cases, the activities of a foreign banking institution can be terminated.
Finally, Federal Reserve officials participate in various international organizations, such as the Bank for International Settlements, to address issues of global concern, such as capital standards for international banks; Fed officials also maintain contact with foreign central banks regarding issues of mutual concern.