Is controlling interest rates or money supply more important for exchange rates?

Beginner Questions
1

Hi Everybody,

I’m a newbie here, going through the School of Pipsology.

I just finished my third quiz (still in pre-K), and got this question incorrect:

  1. Which Central Bank policy action tends to have the biggest affect on exchange rates?
    Correct Answer:
    Adjusting interest rates
    Your Answer:
    Controlling the supply of money
    INCORRECT

In the lesson, it mentions that governments and central banks not only control interest rates, but can also directly intervene by starting massive buy/sell operations to alter exchange rates.

Wouldn’t it then follow that Central Bank policy has a huge affect on exchange rates both because of interest rates and because of their ability to control the money supply? Why does adjusting interest rates affect exchange rates more than the money supply, or am I thinking about this completely wrong?

2

Hello,

IMO, when you control the supply of money (e.g. by means of injecting more money into the economy through a stimulus plan) you hope to maintain a certain balance in inflation and try to control it up to a certain level (usually 2%), which in turn you hope that it MAY affect the economic results and later the exchange rate.

On the other hand, when you change the interest rates it will affect us (traders wannabes :slight_smile: ) by the differential between interest rates; and also domestically because it will change the rate at which the local banks will lend the money to the local companies and people and that effect is immediate to us and to their people.

That’s the way I see it, but I am not 100% sure if these are the main reasons.

3

That makes total sense - controlling the money supply indirectly affects us (trader hopefuls:)) and exchange rates while controlling interests directly affects exchange rates.

Thank you for responding with such a thoughtful answer, and clearing that up for me.