ABSTRACT
Exchange rate policy is almost a misnomer. The government cannot decree that the exchange rate will from a given Sunday in March stand at such and such a level in the way it can organise the start of British Summer Time. What it can do, at least over limited periods, is instruct government departments, including the central bank, to arrange their affairs so that the exchange rate follows a given path. The direct policy of market intervention is an instruction to buy or sell foreign exchange in the market to prevent the exchange rate from moving away from its target path. The exchange rate is not unique in being amenable only to indirect control - interest rates are equally determined by the authorities' willingness to buy or sell securities in response to market pressure. Because the exchange rate is not set by decree, the way that other macroeconomic policies are conducted will often have implications for the path of the exchange rate, and a decision to influence the exchange rate in some way may restrict the choice of paths for other policies. When policy instruments are selected in a co-ordinated fashion which allows for their interactions no particular problem arises, apart from the formidable practical one of assessing just what the strengths of the interactions are. When policy is promulgated as a series of rules for individual policy variables problems of consistency may arise if the rules were not fully co-ordinated in the first place or, more reasonably, if circumstances change to bring previously consistent rules into conflict. This chapter examines the relationships between some policy instruments and the exchange rate.
