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On the theory of sterilized foreign exchange intervention

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  • Kumhof, Michael

Abstract

Standard theory finds that, given uncovered interest parity, sterilized foreign exchange intervention should not affect equilibrium prices and quantities. This paper shows that when, as in the data, taxation is not sufficiently flexible in response to spending shocks, uncovered interest parity is replaced by a monotonically increasing relationship between the stock of domestic currency government debt and domestic interest rates. Sterilized intervention then becomes a second independent monetary policy instrument that affects portfolios, interest rates, exchange rates and consumption. It should be most effective in developing countries, where fiscal spending volatility is large and domestic currency government debt is small.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 34 (2010)
Issue (Month): 8 (August)
Pages: 1403-1420

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Handle: RePEc:eee:dyncon:v:34:y:2010:i:8:p:1403-1420

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Web page: http://www.elsevier.com/locate/jedc

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Keywords: Uncovered interest parity Imperfect asset substitutability Portfolio balance models Sterilized foreign exchange intervention;

References

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Cited by:
  1. Jaromir Benes & Andrew Berg & Rafael A Portillo & David Vavra, 2013. "Modeling Sterilized Interventions and Balance Sheet Effects of Monetary Policy in a New-Keynesian Framework," IMF Working Papers 13/11, International Monetary Fund.
  2. Rasmus Fatum, 2010. "Foreign Exchange Intervention When Interest Rates Are Zero: Does the Portfolio Balance Channel Matter After All?," EPRU Working Paper Series 2010-07, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  3. Rasmus Fatum & Jesper Pedersen & Peter Norman Sørensen, 2010. "Are the intraday effects of central bank intervention on exchange rate spreads asymmetric and state dependent?," Globalization and Monetary Policy Institute Working Paper 59, Federal Reserve Bank of Dallas.
  4. Charles Engel, 2013. "Exchange Rates and Interest Parity," NBER Working Papers 19336, National Bureau of Economic Research, Inc.
  5. Olivier Jeanne, 2012. "Capital Account Policies and the Real Exchange Rate," NBER Working Papers 18404, National Bureau of Economic Research, Inc.
  6. Fatum, Rasmus & Yamamoto, Yohei, 2014. "Large versus small foreign exchange interventions," Journal of Banking & Finance, Elsevier, vol. 43(C), pages 114-123.

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