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Offset and Sterilization Under Fixed Exchange Rates With An Optimizing Central Bank

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  • Nouriel Roubini

Abstract

The traditional approach to the estimation of the offset and sterilization equations can be criticized for the ad-hoc specification of the reaction function of the monetary authorities and the endogeneity of the domestic credit and foreign reserve variables in the estimated equations. The paper proposes an alternative analytical model where the sterilization and offset equations are derived from an explicit maximization problem solved by the monetary authority. In such a model, the optimal intervention and sterilization policies of the monetary authority are shown to be dependent on the different disturbances hitting the economy and the preferences of the monetary authority. In particular, under a wide range of domestic and foreign disturbances the optimal response of the central bank will lead to negatively correlated comovements of domestic credit and foreign reserves if the cer1tral bank cares more about the interest rate smoothing objective relative to the foreign exchange reserve stabilization goal. Conversely, positive correlations between domestic credit and foreign reserves will be observed if the foreign reserve objective is dominant.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2777.

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Date of creation: Nov 1988
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Handle: RePEc:nbr:nberwo:2777

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  1. Aoki, Masanao, 1977. "A note on the stability of the interaction of monetary policies," Journal of International Economics, Elsevier, Elsevier, vol. 7(1), pages 81-94, February.
  2. Neumann, Manfred J. M., 1978. "Offsetting capital flows : A reexamination of the German case," Journal of Monetary Economics, Elsevier, Elsevier, vol. 4(1), pages 131-142, January.
  3. Robert J. Barro, 1988. "Interest-Rate Smoothing," NBER Working Papers 2581, National Bureau of Economic Research, Inc.
  4. Obstfeld, Maurice, 1982. "Can We Sterilize? Theory and Evidence," American Economic Review, American Economic Association, American Economic Association, vol. 72(2), pages 45-50, May.
  5. Kouri, Pentti J. K., 1975. "The hypothesis of offsetting capital flows : A case study of Germany," Journal of Monetary Economics, Elsevier, Elsevier, vol. 1(1), pages 21-39, January.
  6. Vaubel, Roland, 1980. "The return to the new european monetary system : Objectives, incentives, perspectives," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 13(1), pages 173-221, January.
  7. Neumann, Manfred J. M., 1984. "Intervention in the mark/dollar market: the authorities' reaction function," Journal of International Money and Finance, Elsevier, Elsevier, vol. 3(2), pages 223-239, August.
  8. Marston, Richard C., 1980. "Cross country effects of sterilization, reserve currencies, and foreign exchange intervention," Journal of International Economics, Elsevier, Elsevier, vol. 10(1), pages 63-78, February.
  9. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
  10. 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.
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Cited by:
  1. repec:onb:oenbwp:y::i:20:b:1 is not listed on IDEAS
  2. Kenneth Kletzer & Mark Spiegel, 1999. "Sterilization costs and exchange rate targeting," Pacific Basin Working Paper Series, Federal Reserve Bank of San Francisco 99-03, Federal Reserve Bank of San Francisco.
  3. Eichengreen, Barry, 1989. "International Monetary Istability Between the Wars: Structural Flaws or Misguided Policies?," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt5r60q801, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  4. Caprio, Gerard & Honohan, Patrick, 1990. "Monetary policy instruments for developing countries," Policy Research Working Paper Series, The World Bank 528, The World Bank.
  5. Sarno, Lucio & Taylor, Mark P, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective, and, If So, How Does It Work?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2690, C.E.P.R. Discussion Papers.
  6. Johannes Groeneveld, 1998. "From the ERM with Love: Monetary Spillover Effects to Austria," Empirica, Springer, Springer, vol. 25(3), pages 331-345, January.
  7. Hans Groeneveld, 1995. "Monetary Spill-over Effects in the ERM: The Case of Austria, a Former Shadow Member," Working Papers, Oesterreichische Nationalbank (Austrian Central Bank) 20, Oesterreichische Nationalbank (Austrian Central Bank).
  8. Buch, Claudia M. & Lusinyan, Lusine & Engerer, Hella & Lodahl, Maria & Schrettl, Wolfram & Schrooten, Mechthild, 2000. "Russlands Wirtschaftspolitik setzt auf Investitionen," Kiel Discussion Papers, Kiel Institute for the World Economy (IfW) 360, Kiel Institute for the World Economy (IfW).
  9. Gyuhan Kim, 1995. "Exchange rate constraints and money control in Korea," Working Papers, Federal Reserve Bank of St. Louis 1995-011, Federal Reserve Bank of St. Louis.
  10. Claudia M. Buch & Elke Hanschel, 1999. "The Effectiveness of Capital Controls � The Case of Slovenia," Kiel Working Papers 933, Kiel Institute for the World Economy.

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