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Sterilized Intervention in Forex: What it Means, Examples

Definition
Sterilized intervention is action taken by a country's central bank to influence the exchange value of the domestic currency, without changing the monetary base.

What Is Sterilized Intervention?

Sterilized intervention is the purchase or sale of foreign currency by a central bank to influence the exchange value of the domestic currency, without changing the 澳洲幸运5官方开奖结果体彩网:monetary base.

Key Takeaways

  • Sterilized intervention is the purchase or sale of foreign currency by a central bank to influence the exchange value of the domestic currency, without changing the monetary base. 
  • Sterilized interventions involve the sale or purchase of foreign currency assets and an open market operation involving the purchase or sale of government securities (in the same size as the first transaction).
  • Empirical evidence suggests that sterilized intervention is generally incapable of altering exchange rates.

Understanding Sterilized Interventions

One of the main tools used by the Federal Reserve to influence monetary policy is its target for the federal funds rate, which is set by the 澳洲幸运5官方开奖结果体彩网:Federal Open Market Committee primarily to achieve domestic objectives. Since the Federal Reserve would never permit its intervention activities to have an impact on its monetary policy operations, it always uses sterilized intervention. Central banks of major nations—such as the 澳洲幸运5官方开奖结果体彩网:Bank of Japan and the 澳洲幸运5官方开奖结果体彩网:European Central Bank—whiꦛch also use an overnight interest rate as a short-term operating target, likewise sterilize their currency interventions.

The 澳洲幸运5官方开奖结果体彩网:U.S. Treasury Department is responsible for determining the nation’s exchange rate, and for that purpose, it maintains the 澳洲幸运5官方开奖结果体彩网:Exchange Stabilization Fund (ESF), which is a portfolio of foreign currency and dollar-denominated assets. The Federal Reserve also has a foreign currency portfolio for the same purpose. Exchange rate intervention is carried out jointly by the Treasury and🍨 Fꦆederal Reserve.

Sterilized⛎ interventions involve two separat🌠e transactions:

  1. The sale or purchase of foreign currency assets
  2. An open market operation involving the purchase or sale of 澳洲幸运5官方开奖结果体彩网:government securities (in the same size as the first transaction).

The open market operation effectively offsets or sterilizes the impact of the intervention on the monetary base. If the sale or purchase of the foreign currency is not accompanied by an open market 📖operation, it would amount to an unsterilized intervention. Empirical evidence suggests that sterilized intervention is generally incapable of altering exchange rates.

Example of Sterilized Intervention

Consider a simple example of sterilized intervention. Assume that the Federal Reserve is concerned about the weakness of the dollar against the euro. It, therefore, sells euro-denominated bonds in the amount of EUR 10 billion, and it receives $14 billion in proceeds from the bond sale. Since the withdrawal of $14 billion from the banking system to the Federal Reserve would affect the 澳洲幸运5官方开奖结果体彩网:federal funds rate, the Federal Reserve will immediately conduct an open market operation and buy𝐆 $14 billion of U.S. Treasuries.

This injects the $14 billion back into the monetary system, sterilizing the sale of the euro-denominated bonds. The Federal Reserve in effect also shuffles its bond 澳洲幸运5官方开奖结果体彩网:portfolio by exchang✱iꩵng euro-denominated bonds for U.S. Treasuries.

Sterilized Intervention vs. Carry Trade

Towards the end of the last century, a common cause of many sterilized interventions was a high money supply which pushed local interest rates below the international average, which created the conditions for a carry trಞade—market participants would borrow at home and lend abroad at a higher interest rate.

Carry trade exerts downward pressure on the currency bei🍌ng borrowed. As sterilized interventions do not reduce an already high money supply, domestic interest rates will still be low. Participants continue borrowing at home and lending abroad and the central bank has to intervene again if it wants to prevent any future depreciation of its domestic currency. This cannot go on forever, because the central bank will eventually run outꦏ of currency reserves.

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