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Exchange Rates, Inflation and the Sterilization Problem: Germany, 1975-1981

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  • Maurice Obstfeld

Abstract

When the goals of internal and external macroeconomic equilibrium are in conflict, sterilized intervention in the foreign exchange market may provide an independent policy instrument through which the central bank can resolve its dilemma in the short run. This paper is concerned with the West German Bundesbank's use of sterilization during the recent years of exchange- rate flexibility. The paper asks whether the Bundesbank pursued sterilization during the years 1995-1981, and whether sterilized foreign exchange intervention exerts a significant influence on the exchange rate in the German case. Estimation of a stylized Bundesbank reaction function suggests an affirmative answer to the first of these questions. To assess the efficacy of sterilized intervention, a structural portfolio balance model of German asset markets and prices is estimated. Dynamic perfect-foresight simulations of the empirical model are used to ascertain whether imperfect substitutability between foreign and domestic bonds is sufficient to allow the Bundesbank to attain independent internal and external goals over the short run of about a month. The model's verdict is that the Bundesbank has little if any power to influence the exchange rate over that time span without altering current or expected future money-market conditions.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0963.

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Date of creation: Aug 1982
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Publication status: published as Obstfeld, Maurice. "Exchange Rates, Inflation, and the Sterilization Problem. Germany, 1975-1981." European Economic Review, Vol. 21, No. 1/2 (March /April 1983), pp.161-189.
Handle: RePEc:nbr:nberwo:0963

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  1. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1977. "Exchange rates in the short run: The dollar-dentschemark rate," European Economic Review, Elsevier, Elsevier, vol. 10(3), pages 303-324.
  2. Frankel, Jeffrey A., 1979. "The diversifiability of exchange risk," Journal of International Economics, Elsevier, Elsevier, vol. 9(3), pages 379-393, August.
  3. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(2), pages 370-84, April.
  4. Michael R. Darby & Alan C. Stockman, 1980. "The Mark III International Transmission Model," NBER Working Papers 0462, National Bureau of Economic Research, Inc.
  5. Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, Elsevier, vol. 11(4), pages 573-587, November.
  6. Frankel, Jeffrey A., 1983. "Estimation of portfolio-balance functions that are mean-variance optimizing : The mark and the dollar," European Economic Review, Elsevier, Elsevier, vol. 23(3), pages 315-327, September.
  7. Henderson, Dale W, 1979. "Financial Policies in Open Economies," American Economic Review, American Economic Association, American Economic Association, vol. 69(2), pages 232-39, May.
  8. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  9. Cumby, Robert E. & Huizinga, John & Obstfeld, Maurice, 1983. "Two-step two-stage least squares estimation in models with rational expectations," Journal of Econometrics, Elsevier, Elsevier, vol. 21(3), pages 333-355, April.
  10. Maurice Obstfeld, 1980. "The Capitalization of Income Streams and the Effects of Open Market Policy under Fixed Exchange Rates," NBER Working Papers 0528, National Bureau of Economic Research, Inc.
  11. Robert E. Cumby & Maurice Obstfeld, 1980. "Exchange-Rate Expectations and Nominal Interest Differentials: A Test ofthe Fisher Hypothesis," NBER Working Papers 0537, National Bureau of Economic Research, Inc.
  12. Stulz, ReneM., 1982. "The forward exchange rate and macroeconomics," Journal of International Economics, Elsevier, Elsevier, vol. 12(3-4), pages 285-299, May.
  13. Obstfeld, Maurice, 1980. "Imperfect asset substitutability and monetary policy under fixed exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 10(2), pages 177-200, May.
  14. Michael R. Darby & Alan C. Stockman, 1983. "The Mark III International Transmission Model: Estimates," NBER Chapters, National Bureau of Economic Research, Inc, in: The International Transmission of Inflation, pages 113-161 National Bureau of Economic Research, Inc.
  15. John R. Martin & Paul R. Masson, 1979. "Exchange Rates and Portfolio Balance," NBER Working Papers 0377, National Bureau of Economic Research, Inc.
  16. Richard C. Marston, 1979. "Cross Country Effects of Sterilization, Reserve Currencies and Foreign Exchange Information," NBER Working Papers 0391, National Bureau of Economic Research, Inc.
  17. Herring, Richard J. & Marston, Richard C., 1977. "Sterilization policy: The trade-off between monetary autonomy and control over foreign exchange reserves," European Economic Review, Elsevier, Elsevier, vol. 10(3), pages 325-343.
  18. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
  19. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  20. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1979. "Exchange rates in the short run : Some further results," European Economic Review, Elsevier, Elsevier, vol. 12(4), pages 395-402, October.
  21. Jacques R. Artus, 1981. "Monetary Stabilization with and without Government Credibility (Stabilisation monétaire avec ou sans crédibilité gouvernementale) (Estabilización monetaria y credibilidad del gobierno)," IMF Staff Papers, Palgrave Macmillan, vol. 28(3), pages 495-533, September.
  22. Dooley, Michael & Isard, Peter, 1982. "A portfolio-balance rational-expectations model of the dollar-mark exchange rate," Journal of International Economics, Elsevier, Elsevier, vol. 12(3-4), pages 257-276, May.
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Cited by:
  1. Sung Yeung Kwack, 2001. "An Empirical Assessment Of Monetary Policy Responses To Capital Inflows In Asia Before The Financial Crisis," International Economic Journal, Taylor & Francis Journals, Taylor & Francis Journals, vol. 15(1), pages 95-113.
  2. Adrian Blundell-Wignall & Frank Browne, 1992. "Real Exchange Rates and the Globalisation of Financial Markets," RBA Research Discussion Papers, Reserve Bank of Australia rdp9203, Reserve Bank of Australia.
  3. Pierre L. Siklos, 2000. "Capital flows in a transitional economy and the sterilization dilemma: The hungarian experience, 1992-97," Journal of Economic Policy Reform, Taylor & Francis Journals, Taylor & Francis Journals, vol. 3(4), pages 373-392.
  4. Kiss M., Norbert, 2005. "A jegybanki devizapiaci intervenció hatékonysága. Nemzetközi tapasztalatok és elméleti megfontolások
    [Effectiveness of central-bank intervention on foreign-exchange markets. International ex
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(11), pages 846-872.
  5. V A Muscatelli & Patrizio Tirelli, 1995. "Institutional Change, Inflation Targets and the Stability of Interest Rate Reaction Functions in OECD Economies"," Working Papers, Business School - Economics, University of Glasgow 9606, Business School - Economics, University of Glasgow, revised Apr 1996.
  6. Owen F. Humpage, 1991. "Central-bank intervention: recent literature, continuing controversy," Economic Review, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, issue Q II, pages 12-26.

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