Why central banks buy their own or other nations currency to control exchange rates?

Answer 1

This is called the monetary policy which aims to control money supply and interest rate to control the amount of money circulating in an economy.

Countries do this for several reasons:

• Reduce inflation: Inflation happens because there are too much money in the economy. Therefore, they can buy their own currency (by selling assets) to reduce the amount of money in the economy => reduced inflation
• Reduced current account deficit (surplus): In this case, central banks "buy" the currency so it will be to reduce the current account surplus, thus putting downward pressure to inflation. This is because as there are less money in the economy, the value of the money goes up i.e. its exchange rate relative to other currencies go up, making its export less competitive and imports more competitive, reducing current account surplus.
• Stability: Although this is not explicitly said, countries do aim for a stable exchange rate so that investor confidence can be confident enough to invest. This is done by controlling the money supply (as said above.)

Answer 2

If the central bank did not act to support the stated foreign-exchange rate, then too much or too little of one currency would be supplied or demanded.