Wednesday, October 31, 2007

Who Sets American Exchange Rate Policy?

. Wednesday, October 31, 2007

A reader posed a question in a comment on an earlier post: "LeMonde today had a long op-ed on the European reponse to the high Euro and in it the author claimed that "La politique de change americaine est du seul ressort de la Maison Blanche, la Fed n'ayant pas son mot a dire sur le sujet." (Exchange rate policy is a White House resort only, the Fed does not say a thing about this). This confuses me. I thought interest rates were the main leverage of nations to impact exchange rates and those are clearly left to the Fed. So how can the White House be responsible for the exchange rate if they cannot regulate it in anyway?"

This is a good question; the short answer is that the Treasury and the Fed have separate authority to engage in foreign exchange market intervention. Treasury (executive branch) appears to have the upper hand. Yet, the Fed also has legal authority over interest rates. Practically speaking, then, the question of who controls exchange rate policy depends upon whether forex intervention is an effective instrument. As most economists seem to agree that it is not (which is why the US rarely engages in forex intervention), then practical authority would seem to lie with the Fed via their control of interest rates.

It is not altogether clear who has final say in the event of a conflict between exchange rate and domestic monetary objectives--can the Treasury force the Fed to expand the money supply to depreciate the dollar? Can the Fed force the Treasury to accept a dollar value in order to achieve its domestic monetary goals?

I think that exchange rate policy in the euro zone is similarly ambiguous; the ECB controls monetary policy while the Council of Ministers has the authority to set broad exchange rate objectives. What happens, who has ultimate authority, when they conflict is unclear. (on the ECB and Council, see here, Article 109).

Here's a longer (and more authoritative) answer from the New York Federal Reserve Bank (page 87):

By law and custom, the Secretary of the Treasury is primarily and directly responsible to the President and the Congress for formulating and defending U.S. domestic and international economic policy, assessing the position of the United States in the world economy, and conducting international negotiations on these matters. At the same time, foreign exchange markets are closely linked to money markets and to questions of monetary policy that are within the purview of the Federal Reserve. There is a distinct role and responsibility for the Federal Reserve,working with the Treasury and in cooperation with foreign central banks that operate in their own markets. For many years, the Treasury and the Federal Reserve have recognized the need to cooperate in the formulation and implementation of exchange rate policy.

The Treasury and the Federal Reserve each have independent legal authority to intervene in the foreign exchange market. Since 1978, the financing of U.S. exchange market operations has generally been shared between the two. Intervention by the Treasury is authorized by the Gold Reserve Act of 1934 and the Bretton Woods Agreements Act of 1944. Intervention by the Federal Reserve System is authorized by the Federal Reserve Act. It is clear that the Treasury cannot commit Federal Reserve funds to intervention operations. It also is clear that any foreign exchange operations of the Federal Reserve will be conducted,in the words of the Federal Open Market Committee (FOMC),“in close and continuous cooperation with the United States Treasury.” In practice, any differences between the Treasury and the Federal Reserve on these matters have generally been worked out satisfactorily.

Cooperation is facilitated by the fact that all U.S.foreign exchange market operations are conducted by the Foreign Exchange Desk of the Federal Reserve Bank of New York, acting as agent for both the Treasury and the Federal Reserve System.


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Who Sets American Exchange Rate Policy?




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