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Foreign exchange intervention and sterilization: an investigation of State Bank of Pakistan’s Reaction Function

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  • Waheed, Muhammad
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    Abstract

    We looked into Pakistan’s central bank response to the foreign exchange inflows, for the period from 2001:01 to 2007:06, to strike a balance between competing goals of internal and external equilibriums to draw lessons for its conduct going forward. Using a reaction function we tested the hypothesis that SBP fully sterilized its foreign exchange interventions. The results indicated that for this period, SBP only partially neutralized its foreign exchange interventions. In addition, we also found that changes in SBP’s domestic credit were counter cyclical as it had negative relation with the output gap. However, the changes in domestic credit were found to have positive relation with changes in inflation. This probably resulted from too much weight assigned to growth objective in the back drop of recession and low inflation environment at the start of 2001. It was also found that the SBP also change its domestic credit systematically to reduce interest rate variability at the short end.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 33161.

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    Date of creation: Jan 2010
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    Handle: RePEc:pra:mprapa:33161

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    Keywords: Foreign Exchange; Inflows; Sterilization; State Bank of Pakistan; Reaction Function;

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    1. Argy, V. E. & Murray, G. L., 1985. "Effects of sterilising a balance of payments surplus on domestic yields--A formal analysis," Journal of International Money and Finance, Elsevier, vol. 4(2), pages 223-236, June.
    2. Tomas Holub, 2004. "Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience," Research and Policy Notes 2004/01, Czech National Bank, Research Department.
    3. Joshua Aizenman & Reuven Glick, 2008. "Sterilization, Monetary Policy, and Global Financial Integration," NBER Working Papers 13902, National Bureau of Economic Research, Inc.
    4. Reinhart, Carmen & Calvo, Guillermo & Leiderman, Leonardo, 1993. "“Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," MPRA Paper 7125, University Library of Munich, Germany.
    5. 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, vol. 3(4), pages 373-392.
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    7. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
    8. Reinhart, Carmen & Reinhart, Vincent, 1998. "“Some Lessons for Policy Makers Who Deal with the Mixed Blessing of Capital Inflows,”," MPRA Paper 7123, University Library of Munich, Germany.
    9. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
    10. Savvides, Andreas, 1998. "Inflation and monetary policy in selected West and Central African countries," World Development, Elsevier, vol. 26(5), pages 809-827, May.
    11. Miller, Norman C & Atkinson, Sherry S, 1980. "Monetary Policy and the Balance of Payments in Brazil and Chile: A Reply," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 550-51, August.
    12. Sheehey, Edmund J, 1980. "Monetary Policy and the Balance of Payments in Brazil and Chile: A Comment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(3), pages 547-49, August.
    13. M S Mohanty & Philip Turner, 2005. "Intervention: what are the domestic consequences?," BIS Papers chapters, in: Bank for International Settlements (ed.), Foreign exchange market intervention in emerging markets: motives, techniques and implications, volume 24, pages 56-81 Bank for International Settlements.
    14. Leiderman, Leonardo, 1984. "On the monetary-macro dynamics of Colombia and Mexico," Journal of Development Economics, Elsevier, vol. 14(1), pages 183-201.
    15. Miller, Norman C & Askin, Sherry S, 1976. "Monetary Policy and the Balance of Payments in Brazil and Chile," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(2), pages 227-38, May.
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