On the Rotation of the Earth, Drunken Sailors, and Exchange Rate Policy

Reading 43 is "On the Rotation of the Earth, Drunken Sailors, and Exchange Rate Policy." This reading evaluates the notion that official foreign exchange market intervention can alter a currency's value over the long-run, concluding that it cannot and thus has limited value.

1. Define the following terms used in the reading:
   1. intervention
   2. open market operation
   3. sterilize
   4. forward looking

2. How does central bank intervention in foreign exchange markets affect bank reserves and the money supply?

3. Why do central banks typically sterilize their foreign exchange interventions?

4. Can sterilized interventions have short-run effects on exchange rates? Why?

5. What are the macroeconomic implications of the drunken sailor analogy for understanding and predicting exchange rates?

Source: "On the Rotation of the Earth, Drunken Sailors, and Exchange Rate Policy." Owen F. Humpage, Federal Reserve Bank of Cleveland Economic Commentary, February 15, 2004, pp. 1-3.