Governments cannot “manipulate” interest or exchange rates

A pugnaciously persistent meme, even among educated people and policymakers who should know better, is that governments at times “manipulate” the interest or exchange rates. By that it is meant that they move the rates away from some mythical “natural” value that they would be at in the absence of the alleged manipulation.

There is no natural rate. A governments is a monopoly supplier of its own government paper and while there are several suppliers of such paper, they’re not direct substitutes for each other. If you want USD cash or bonds, there’s only one shop in town, this is the US government’s (we here consider the central bank and the treasury as one entity given that they both manage the whole stock of government paper, central bank cash is just essentially a very short duration government bond).

Thus, the government is like any monopoly supplier of an exclusive product which has no directly fungible substitute, a price setter — unlike suppliers of fungible commodities who are individually price takers. So, like any monopoly supplier, while they cannot control external demand, they can choose the point on the demand curve, through setting either the quantity (how many bonds or cash they make available) or the price (the interest rate). They might practically set one or the other, but in all case they are choosing a point on the demand curve and which of the axes you use for that setting is a not very interesting technicality.

Not only they choose that, but they cannot opt not to choose. There is no “natural” point on the demand curve. The treasury cannot say they will issue “some” bonds at “some” price and not specify any price or quantity. Buyers of bonds cannot get not-a-number of bonds and receive not-a-number interest on it. Therefore the government is, like all monopoly suppliers of non fungible products, “manipulating” the interest rate at all times. It cannot not manipulate. And there’s nothing wrong with it for there exist no possible state of non-manipulation. Monopoly suppliers are price setters, this is just a fact of life. Buy the product if you like the offer, move on if you don’t.

The same apply to exchange rates, which is just the relative price and directly depends on supply which is just a consequence of setting a point on the demand curve, which in aggregate includes international demand. Exchange controls or the lack thereof doesn’t change that, they just make the currency more or less fungible which is just a quirky way to set quantity. Adding or removing price controls doesn’t change that governments are in full control of their position on the demand curve and have no way to relinquish that control.


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