Sterilized Intervention

11 Key excerpts on "Sterilized Intervention"

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  Multinational Financial Management

  • Alan C. Shapiro, Paul Hanouna(Authors)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  Because Sterilized Intervention entails a substitution of foreign currency-denominated securities for domestic currency securities, 10 the exchange rate will be permanently affected only if investors view domestic and foreign securities as being imperfect substitutes. If this is the case, then the exchange rate and relative interest rates must change to induce investors to hold the new portfolio of securities. For example, if the Bank of Japan sells yen in the foreign exchange market to drive down its value, investors would find themselves holding a larger share of yen assets than before and fewer dollar bonds. At prevailing exchange rates, if the public considers assets denominated in yen and in dollars to be imperfect substitutes for each other, people would attempt to sell these extra yen assets to rebalance their portfolios. As a result, the value of the yen would fall below its level absent the intervention. At the same time, the interest rate on yen bonds will be higher and the dollar interest rate lower than otherwise. If investors consider these securities to be perfect substitutes, however, then no change in the exchange rate or interest rates will be necessary to convince investors to hold this portfolio. In this case, Sterilized Intervention is ineffectual. This conclusion is consistent with the experiences of Mexico as well as those of the United States and other industrial nations in their intervention policies. For example, Figure 2.7 shows a sequence of four large currency interventions by the Swiss National Bank between 2009 and 2010 to weaken 10 Central banks typically hold their foreign exchange reserves in the form of foreign currency bonds. Sterilized Intervention to support the domestic currency, therefore, involves selling off some of the central bank’s foreign currency bonds and replacing them with domestic currency ones. Following the intervention, the public will hold more foreign currency bonds and fewer domestic currency bonds.

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  Exchange Rates, Capital Flows and Policy

  • Rebecca Driver, Peter J N Sinclair, Christoph Thoenissen(Authors)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  The extent to which a central bank sterilizes the effect of foreign exchange intervention on the monetary base can vary with many factors. Among those are capital mobility, different types and nature of disturbances underlying movements in exchange rate, business cycle, fiscal flexibility, and private agents’ asset demand behavior (Calvo 1991; Frankel 1994; Kletzer and Spiegel 1996; Glick and Hutchison 2000). There is little scope for sterilization as financial markets are increasingly globalized and in turn capital mobility or substitutability between foreign and domestic assets becomes greater and greater. Although Sterilized Intervention remains feasible to some degree, its effectiveness depends on the way it is implemented. Furthermore, monetary policy will be independent of exchange rate policies only if foreign exchange interventions are completely sterilized in the long run. The fact that the degree of short-term sterilization is high has no significant implications for monetary control, while it can reduce the initial impact of intervention on the monetary base and distribute its effect more smoothly over time.

  This chapter presents an empirical analysis of the relationship between foreign exchange market intervention and monetary controls in Korea over the managed floating exchange rate period 1981–2001. The study investigates how the Korean monetary authorities intervened in the foreign exchange market in response to exchange rate movements, and the extent to which such exchange rate policies might have influenced the monetary base and money supply or interest rates. The rest of the chapter is organized as follows. Section 2 sets out balance of payments and central bank balance sheet identities as well as monetary policy reaction functions and reviews the theoretical predictions of the possible linkages between foreign exchange interventions, sterilization, and monetary controls. Section 3.1 reviews some stylized facts about movements in the exchange rate of the Korean won against the US dollar, official foreign reserves, and related variables during the period 1981–2001. Section 3.2 and 3.3 present econometric analyses of the behavior of foreign exchange intervention and sterilization respectively. Section 4

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  International Financial Management

  • Alan C. Shapiro, Peter Moles(Authors)
  • 2014(Publication Date)
  • Wiley

    (Publisher)

  If the Federal Reserve buys enough T-bills, the U.S. money supply will return to its pre-intervention level. Similarly, the ECB could 78 EXCHANGE RATE DETERMINATION neutralize the impact of intervention on the Eurozone money supply by subtracting reserves from its banking system through sales of euro-denominated securities. For example, during a three-month period in 2003 alone, the People’s Bank of China (PBOC) issued 250 billion yuan in short-term notes to commercial banks to sterilize the yuan created by its foreign exchange market intervention. The PBOC also sought to mop up excess liquidity by raising its reserve requirements for financial institutions, forcing banks to keep more money on deposit with it and make fewer loans. The net result of sterilization should be a rise or fall in the country’s foreign exchange reserves but no change in the domestic money supply. The Effects of Foreign Exchange Market Intervention The basic problem with central bank intervention is that it is likely to be either ineffectual or irre- sponsible. Because Sterilized Intervention entails a substitution of foreign currency-denominated securities for domestic currency securities, 12 the exchange rate will be permanently affected only if investors view domestic and foreign securities as being imperfect substitutes. If this is the case, then the exchange rate and relative interest rates must change to induce investors to hold the new portfolio of securities. For example, if the Bank of Japan sells yen in the foreign exchange market to drive down its value, investors would find themselves holding a larger share of yen assets than before and fewer foreign currency bonds. At prevailing exchange rates, if the public considers assets denominated in yen and in foreign currencies to be imperfect substitutes for each other, people would attempt to sell these extra yen assets to rebalance their portfolios. As a result, the value of the yen would fall below its level absent the intervention.

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  The Economics of Exchange Rates

  • Lucio Sarno, Mark P. Taylor(Authors)
  • 2003(Publication Date)
  • Cambridge University Press

    (Publisher)

  For example, Obstfeld (1983) examines the Bundesbank’s tendency to sterilise during the sample period 1975–81 and finds that the German central bank sterilised completely during the sample period and attempted to attain domestic objectives using domestic credit policies while using sterilised intervention to stabilise the exchange rate. By contrast, Neumann (1984), Gaiotti, Giucca and Micossi (1989) and von Hagen (1989) provide evidence that the Bundesbank’s sterilisation is generally not complete, but rather that the degree of sterilisation varies over time (Neumann’s sample period overlaps with the one in Obstfeld’s study, while Gaiotti, Giucca and Micossi use data for the period 1973–87). Von Hagen (1989) and Neumann and von Hagen (1991) distinguish between the behaviour of the Bundesbank in the short and long runs and conclude that sterilisation is full in the short run but only partial in the long run, i.e. that the Bundesbank does not sterilise intervention permanently. Also, using Japanese data, some researchers provide evidence suggesting that the Bank of Japan fully sterilises its intervention. While this result is very strong in Gaiotti, Giucca and Micossi’s (1989) study, Takagi (1991) could detect some variation in the degree of sterilisation of the Bank of Japan and found, in particular, that the degree of sterilisation used by the Bank of Japan seems to have decreased over time during the post-Bretton Woods period. 40 More recently, Almekinders and Eijffinger (1996) have proposed a novel approach to deriving a central bank intervention reaction function. In particular, a generalised autoregressive conditional heteroscedasticity model for exchange rates is amended to allow intervention to have an effect on both the mean and the variance of exchange rate returns. An intervention reaction function is obtained by combining the model with a loss function for the central bank.

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  Regional and Global Capital Flows

  Macroeconomic Causes and Consequences

  • Takatoshi Ito, Anne O. Krueger, Takatoshi Ito, Anne O. Krueger(Authors)
  • 2009(Publication Date)
  • University of Chicago Press

    (Publisher)

  The frequently used mone-tary measures comprise open market sales of domestic securities (a con-ventional form of Sterilized Intervention), increase in reserve requirements, shifting of government deposits from commercial banks to central banks, increase in discount rates, moral suasion, and credit controls. The paper set out the hypothesis that e ff ective sterilization not only lim-its the growth of monetary aggregates but also raises the level of domestic Mahani Zainal-Abidin is professor in the Department of Applied Economics at the Uni-versity of Malaya, Kuala Lumpur. Sterilization and the Capital Inflow Problem in East Asia 227 interest rates. The resulting higher interest rate from sterilization measures will in fact encourage more capital inflow, and in the end it will become unsustainable, due to its high cost and the expansionary e ff ects of an even larger inflow. Therefore, the measures to stem the huge short-term capital inflow into East Asian countries will, paradoxically, further aggravate the problem. In other words, could this large inflow, which was one of the causes of the 1997–98 East Asian economic and financial crisis, have been policy induced through higher interest rates as a result of the sterilization e ff orts? The paper’s regression estimates showed that sterilization was e ff ective in limiting the growth of monetary aggregates, but it did not produce a higher level of interest rate. The regression also estimated the e ff ects on monetary aggregates when sterilization was intense and showed that al-though the sterilization result was stronger during the period of unusually large inflow, the general restraining e ff ects from sterilization were present throughout the entire period of capital inflow. In contrast, the relationship between sterilization and interest rate was found to be insignificant, and this was attributed to the lack of a systematic relationship between the two variables.

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  The Development of International Monetary Policy

  • Christopher Warburton(Author)
  • 2017(Publication Date)
  • Taylor & Francis

    (Publisher)

  Table 7.2 . The sample sizes have variations because of the varying number of willing respondents. The number of respondents is much smaller for Asia, relative to Latin America. Based on daily foreign exchange market turnover, two central banks in Emerging Europe intervened more aggressively. However, from 2007 to 2012, the size of interventions seems to be generally irregular.

  The size of intervention relative to FX market turnover is symptomatic of a central banks’ market power to affect the current exchange rate, and its share in FX reserves as a measure of their potential strength to influence the future exchange rate. As a group, the Emerging Economies seem to have some amount of market power though their collective strength declined after 2007. The Banks of Korea, Poland, and India intervened to stabilise their currencies after the 2007 crisis (Mohanty and Berger 2013: 61–2).

  Beyond the stabilisation of fixed exchange rates, sterilised interventions (those dealing with disruptive capital flows) are designed to attain external stability rather than domestic or internal stability. Central banks may purchase and sell foreign currencies in a manner that is not intended to alter the domestic monetary conditions, base money supply (money as a medium of exchange and store of value), and implicitly, the short-term interest rate.

  The manipulation of the value of a currency falls within a broader spectrum of politics, economics, and law. Implicitly, by the connotation of verbiage, the practice of manipulation is designed to gain undue competitive advantage, which may or may not be disruptive. Since the effects of manipulation have implications for fair international trade, one might reasonably presume that the World Trade Organization (WTO) should have authoritative rights to adjudicate the effects of unwarranted currency valuation. Apparently, exchange rates and trade issues are curiously considered to be separate issues for specialised administration. The IMF is responsible for investigating and making a determination that the value of a currency has been manipulated while the WTO is limited to trade issues. This curious anomaly has made it impractical to resolve exchange rate disputes satisfactorily.

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  Recent Experiences with Surges in Capital Inflows

  • Robert Kahn, Adam Bennett, María Carkovic S., and Susan Schadler(Authors)
  • 1993(Publication Date)
  • INTERNATIONAL MONETARY FUND

    (Publisher)

  Sterilization

  Sterilization was the first line of defense against the surge in inflows, regardless of its cause, in each of the countries. Sterilizing was attractive because it could be implemented quickly and bought time to consider the likely causes and persistence of inflows and to formulate a longer-term response. It sought to curb the monetary effect of the inflows and tended to lock in a cushion of reserves against a possible reversal. As inflows persisted most governments eased the degree of sterilization.

  Narrowly defined, sterilization is the exchange of bonds rather than money for foreign exchange. In fact, open-market operations were only one of the mechanisms that central banks employed to limit the influence of capital inflows on money. Increases in reserve requirements on all or selected parts of bank deposits, often designed to lengthen the maturity structure of deposits and discourage foreign inflows to the banking system, were also important. Other sterilization-type policies included various forms of central bank borrowing from commercial banks; the shifting of government deposits from commercial banks to the central bank; raising interest rates on central bank assets and liabilities; curtailing access to rediscount facilities; and, in Spain, direct credit controls. Sterilization was also accomplished through sales of government liabilities: this was important in Egypt, where the Government sold bonds to reduce money creation from deficit financing. To capture the bulk of these mechanisms, a broad measure of sterilization is required—namely, changes in the domestic assets of the central bank net of liabilities to the public sector and banks—that is, the domestic counterpart of currency issue.

  Another difficulty in identifying sterilization is determining causality—whether the reduction in net domestic assets caused subsequent capital inflows or offset previous inflows. In fact, for most of the countries both lines of causality were undoubtedly at play. Except in extreme circumstances—when interest rates are invariant to the supply of bonds or to banks’ free reserves, or inflows are insensitive to interest rate differentials—sterilization will, at least to some degree, increase inflows. Nevertheless, estimates, reported in Appendix I, of the offset coefficient, that is, the degree to which sterilization induces offsetting capital inflows, suggest that, at least historically, the countries under review, with the possible exception of Thailand, had scope for effective sterilization. It must be remembered, however, that for all of these countries domestic financial markets have become increasingly integrated with foreign markets and estimates of offset coefficients using historical data probably underestimate the mobility of capital.

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  Dollar Overvaluation and the World Economy

  • C. Fred Bergsten, John Williamson, C. Fred Bergsten, John Williamson(Authors)
  • 2003(Publication Date)
  • Peterson Institute for International Economics

    (Publisher)

  The Effectiveness of Intervention The literature on the effectiveness of exchange market intervention on spot exchange rates has blossomed since the early 1980s, aided in large part by the studies that were produced at the Federal Reserve and elsewhere as background for the Jurgensen Report. 2 Neither the research that was done as background for the Jurgensen Report nor any of the subsequent research justifies the opinion expressed by Kathryn Dominguez in her paper for this conference that the conventional view as of the early 1990s was that ‘‘intervention could only be effective if combined with contempo-raneous changes in money supply (or, in other words, only if interventions were unsterilized).’’ Sterilized Intervention never has been dead as a policy instrument even for the major economies with large open capital markets; the issue always has been how effective it is and to what extent it can be relied on as an instrument of policy. Research on the effectiveness of intervention has been aided by the gradual relaxation of prohibitions on access to intervention data, but the availability of those data has proven to be less helpful than many had hoped in resolving the basic issues surrounding the effectiveness of inter-vention. One reason is the lack of a robust model explaining exchange rate determination. Dominguez, working alone (1987) and also collaborating with Jeffrey A. Frankel (1993), has been one of the major contributors to this literature. In the paper she presented at this conference, Dominguez continues in that tradition of careful and rich analysis. In part she uses statistical techniques to examine intervention episodes that are as short as a single day and as long as several years. 3 She examines intervention by G-3 (Japanese, German/European, and US) monetary authorities. She presents the results of a range of tests from four-hour effects to 48-hour effects and beyond.

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  Economic Adjustment and Exchange Rates in Developing Countries

  • Sebastian Edwards, Liaquat Ahamed, Sebastian Edwards, Liaquat Ahamed(Authors)
  • 2007(Publication Date)
  • University of Chicago Press

    (Publisher)

  It should be emphasized that this analysis of the interaction between private sector spending behavior and the fiscal effect of sterilized in- tervention in the foreign exchange market does not rely on a traditional real balance effect, in which the level of real money balances influences the desired level of private spending. With a given nominal money supply, incipient differences between spending and income that the private sector plans to finance out of money balances arise only when the government pegs the nominal exchange rate at a value different from that which would prevail under a flexible exchange rate regime. On the other hand, it should also be emphasized that the analysis of this interaction does rely on the assumption that the private sector fails to foresee the effect of current government borrowing and lending (carried out in support of foreign exchange market intervention) on the future tax liabilities of the private sector. If there were a full Ricardian offset of private sector saving for government borrowing, there would be no mechanism through which the flow to government borrowing or the stock of government debt would influence the real sector of the economy. Thus, there would be no way (at least in the context of the 75 Commercial, Fiscal, Monetary, and Exchange Rate Policies present model) for a policy of Sterilized Intervention to maintain the real exchange rate at the level determined by equation (42) if the pegged value of the nominal exchange rate differs from the nominal exchange rate that would prevail under exchange rate flexibility.

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  Strained Relations

  US Foreign-Exchange Operations and Monetary Policy in the Twentieth Century

  • Michael D. Bordo, Owen F. Humpage, Anna J. Schwartz(Authors)
  • 2015(Publication Date)
  • University of Chicago Press

    (Publisher)

  Japan participated, buying nearly $1.7 billion, but Germany remained out of the market. At the 15 November 1994 FOMC meeting, Federal Reserve Bank of Richmond President Broaddus argued against intervention because it must interfere with the Federal Reserve’s monetary-policy independence: As you said, Mr. Chairman, it is now widely agreed that Sterilized Intervention doesn’t have any sustained impact on exchange rates unless it sends a signal that we are going to follow it up with a monetary policy action. This implies, for me at least, and this is really the heart of the matter, that it is not really possible for the Fed to maintain a truly independent monetary policy for an extended period of time while following the Treasury’s lead on foreign exchange policy. Now, of course, in reality the way I see this is that we have maintained our independence by not making a commitment to follow interventions with monetary policy actions. But that’s not a perfect situation either. (FOMC Transcripts, 15 November 1994, 49) In 1995, the Federal Reserve Bank of Richmond articulated the case against intervention (Broaddus and Goodfriend 1996). 46 Although most of the core arguments were well known to FOMC participants, Richmond’s perspective seemed fresh because the authors developed the exposition more completely and clearly than heretofore had been the case. They focused on the connection between intervention and monetary-policy credibility. Sterilized Intervention and the institutions associated with intervention damaged the Federal Reserve’s credibility with respect to price stability, they claimed, because Congress had never statutorily mandated price stability as the Fed’s sole—or even chief—policy goal. The central bank’s credibility with respect to price stability was purely reputation-based. Such credibility is hard to acquire and is inherently fragile

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  Information Spillovers and Market Integration in International Finance

  Empirical Analyses

  • Suk-Joong Kim(Author)
  • 2017(Publication Date)
  • WSPC

    (Publisher)

  1 The BOJ explains in a document on its website (www.boj.or.jp/en/about/basic/etc/faqkainy.htm) that any Yen funds to be sold on foreign exchange markets are raised by issuing Financing Bills. So it appears that it is sterilizing its interventions. However in numerous official statements, it claims that it aims to ensure domestic liquidity is optimal, and these interventions may be used to help achieve that.

  2 This is also referred to as order flow in the literature, and detailed discussion on this issue can be found in Evans and Lyons (2002) and Bacchetta and Wincoop (2003).

  3 This is known as the “hot potato” syndrome (for example, see Lyons, 2001). It occurs when dealers sequentially unload unwanted positions, until eventually a satisfied counterparty is found.

  4 Admati and Pfleiderer (1988) suggested another possible reason for trading volumes to be informative — transaction costs. However these are surely very low in the Yen/USD foreign exchange market.

  5 In a survey of 13 OECD central banks, Lecourt and Raymond (2003) reported that 80% of central banks prefer to deal with major banks, thus ensuring high liquidity and visibility. Sometimes they do trade with brokers, to maintain their anonymity, if their interventions might be interpreted as inconsistent with current monetary policy and thus falsely signal a change. Some central banks, such as the Swiss National Bank, always choose to announce their intervention activities. For the rationales of secret and announced interventions, and corresponding empirical evidence, see inter alia Neely (2001), Dominguez (1998), Kim et al. , (2000), and Beine and Bernal (2004).

  6

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