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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: Jun 1983
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Handle: RePEc:nbr:nberwo:0963

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  1. Cumby, Robert E. & Huizinga, John & Obstfeld, Maurice, 1983. "Two-step two-stage least squares estimation in models with rational expectations," Journal of Econometrics, Elsevier, vol. 21(3), pages 333-355, April.
  2. Obstfeld, Maurice, 1980. "Imperfect asset substitutability and monetary policy under fixed exchange rates," Journal of International Economics, Elsevier, vol. 10(2), pages 177-200, May.
  3. Henderson, Dale W, 1979. "Financial Policies in Open Economies," American Economic Review, American Economic Association, vol. 69(2), pages 232-39, May.
  4. Aliber, Robert Z, 1973. "The Interest Rate Parity Theorem: A Reinterpretation," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1451-59, Nov.-Dec..
  5. Dooley, Michael P & Isard, Peter, 1980. "Capital Controls, Political Risk, and Deviations from Interest-Rate Parity," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 370-84, April.
  6. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1979. "Exchange rates in the short run : Some further results," European Economic Review, Elsevier, vol. 12(4), pages 395-402, October.
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  8. Michael R. Darby & Alan C. Stockman, 1983. "The Mark III International Transmission Model: Estimates," NBER Chapters, in: The International Transmission of Inflation, pages 113-161 National Bureau of Economic Research, Inc.
  9. Dooley, Michael & Isard, Peter, 1982. "A portfolio-balance rational-expectations model of the dollar-mark exchange rate," Journal of International Economics, Elsevier, vol. 12(3-4), pages 257-276, May.
  10. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  11. Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, vol. 11(4), pages 573-587, November.
  12. Maurice Obstfeld, 1982. "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.
  13. John R. Martin & Paul R. Masson, 1979. "Exchange Rates and Portfolio Balance," NBER Working Papers 0377, National Bureau of Economic Research, Inc.
  14. Stulz, ReneM., 1982. "The forward exchange rate and macroeconomics," Journal of International Economics, Elsevier, vol. 12(3-4), pages 285-299, May.
  15. 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, vol. 10(3), pages 325-343.
  16. Michael R. Darby & Alan C. Stockman, 1980. "The Mark III International Transmission Model," NBER Working Papers 0462, National Bureau of Economic Research, Inc.
  17. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1977. "Exchange rates in the short run: The dollar-dentschemark rate," European Economic Review, Elsevier, vol. 10(3), pages 303-324.
  18. Frankel, Jeffrey A., 1979. "The diversifiability of exchange risk," Journal of International Economics, Elsevier, vol. 9(3), pages 379-393, August.
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Cited by:
  1. Owen F. Humpage, 1991. "Central-bank intervention: recent literature, continuing controversy," Economic Review, Federal Reserve Bank of Cleveland, issue Q II, pages 12-26.
  2. V A Muscatelli & Patrizio Tirelli, 1995. "Institutional Change, Inflation Targets and the Stability of Interest Rate Reaction Functions in OECD Economies"," Working Papers 9606, Business School - Economics, University of Glasgow, revised Apr 1996.

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