Did the Intervention Effort by the Thai Government Constitute Direct or Indirect Intervention

1. Did the intervention effort by the Thai government constitute direct or indirect intervention? Explain. The intervention effort by the Thai government constituted direct intervention, since the government exchanged dollar reserves for baht in order to strengthen the currency. This action would increase the demand for baht and the supply of dollars for sale, which puts upward pressure on the baht. In indirect intervention, a central bank attempts to influence the value of a currency by influencing the factors that determine it. For example, if the Thai government wanted to strengthen the baht, it could have increased interest rates by decreasing the Thai money supply.

2. Did the intervention by the Thai government constitute sterilized or nonsterilized intervention? What is the difference between the two types of intervention? Which type do you think would be more effective in increasing the value of the baht? Why?

The intervention by the Thai government constituted nonsterilized intervention. Using nonsterilized intervention, a central bank intervenes in the foreign exchange market without adjusting for the change in money supply. Using sterilized intervention, a central bank intervenes in the foreign exchange market while retaining the money supply. Since the Thai government exchanged dollar reserves for baht in the foreign exchange market, the dollar money supply is increased. An increase in the money supply may decrease U.S. interest rates, which may additionally weaken the dollar with respect to the baht. Therefore, nonsterilized intervention may compound the desired effects of the intervention effort. If the Thai government’s objective is to increase the value of the baht, nonsterilized intervention may be more effective.

3. If the Thai baht is virtually fixed with respect to the dollar, how could this affect U.S. levels of inflation? Do you think these effects on the U.S. economy will be more pronounced for companies such as Blades that operate under trade arrangements involving commitments or for firms that do not? How are companies such as Blades affected by a fixed exchange rate? Under a fixed exchange rate system, inflation may be exported from one country to another. For example, if Thailand experienced relatively high levels of inflation during a fixed exchange rate system, Thai consumers may have switched some of their purchases to U.S. products. Similarly, U.S. consumers may have reduced their imports of Thai goods. This would send Thai production down and unemployment up. Also, it could cause higher inflation in the U.S. due to the excessive demand for U.S. products. Thus, the high inflation in Thailand could cause high inflation in the U.S. For companies such as Blades, this effect would probably be more pronounced as their cost of production would rise, but they export at a fixed price.

4. What are some of the potential disadvantages for Thai levels of inflation associated with the floating exchange rate system that is now used in Thailand? Do you think Blades contributes to these disadvantages to a great extent? How are companies such as Blades affected by a freely floating exchange rate? A freely floating exchange rate may compound Thailand’s inflationary problems. For example, if Thailand experiences high levels of inflation, the baht may weaken. In turn, a weaker baht can cause import prices to be higher, which can increase the prices of Thai materials and supplies and thus increase the price of finished goods. Additionally, higher foreign prices (from the Thai perspective) can force Thai consumers to purchase domestic products.

Blades does not contribute to these problems, as both its exports and imports are denominated in baht. Consequently, a weaker baht would have no direct impact on companies importing from Blades. Blades could still be affected by a freely floating exchange rate system, as it is now subject to exchange rate risk when converting the net baht received to dollars.

5. What do you think will happen to the Thai baht’s value when the swap arrangement is completed? How will this affect Blades? Under the terms of the agreement, completion of the swap arrangement requires Thailand to reverse the swap of its baht reserves for dollars. Specifically, it will have to exchange dollars for baht at a future date. Due to the decline in the value of the baht, however, Thailand’s central bank will need more baht to be exchanged for the dollars needed to repay the other central banks. The purchase of dollars by the Thai government in the foreign exchange market will increase the demand for dollars and the supply of baht for sale, which will put downward pressure on the value of the baht. Since Blades has net inflows in baht, it will be negatively affected by the completion of the swap agreement if the actions needed to complete the agreement result in further weakening of the baht.