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Can Sterilized FX Purchases under Inflation Targeting be Expansionary?

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  • MArcio Gomes Pinto Garcia

    ()
    (Department of Economics PUC-Rio)

Abstract

Unlike common wisdom, sterilized FX purchases under inflation targeting, i.e., those that keep the interest rate at the level targeted by the central bank, generally increase aggregate demand. We resort to a simple model with a credit channel to argue that FX purchases, by funding bank credit, end up increasing aggregate and money demand, while expanding loans and reducing the loan interest rate. Therefore, restoring the interest rate to the level previous to the FX purchase may not be sufficient to avoid the expansionary effect; the new money market equilibrium, at the same interest rate, will entail a larger money supply, higher output and larger money demand. Recent Brazilian evidence is reviewed, showing that this effect may be empirically relevant. If this is the case, inflation targeters may have another reason to be concerned when conducting FX sterilized interventions, besides their high cost and controversial effectiveness in preventing nominal appreciation. FX sterilized purchases may not only fail to prevent nominal appreciation, but also boost activity and inflation, thereby appreciating the real exchange rate.

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Bibliographic Info

Paper provided by Department of Economics PUC-Rio (Brazil) in its series Textos para discussão with number 589.

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Length: 19p
Date of creation: Apr 2011
Date of revision:
Handle: RePEc:rio:texdis:589

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Cited by:
  1. Otaviano Canuto, 2011. "How Complementary Are Prudential Regulation and Monetary Policy?," World Bank Other Operational Studies 10089, The World Bank.
  2. Tamim Bayoumi & Christian Saborowski, 2012. "Accounting for Reserves," IMF Working Papers 12/302, International Monetary Fund.
  3. Canuto, Otaviano & Cavallari, Matheus, 2013. "Monetary policy and macroprudential regulation : whither emerging markets," Policy Research Working Paper Series 6310, The World Bank.
  4. Hernando Vargas Herrera & Andrés González & Diego Rodríguez, 2013. "Foreign Exchange Intervention in Colombia," BORRADORES DE ECONOMIA 010465, BANCO DE LA REPÚBLICA.
  5. Canuto, Otaviano, 2011. "How Complementary Are Prudential Regulation and Monetary Policy?," World Bank - Economic Premise, The World Bank, issue 60, pages 1-7, June.
  6. Moura, Marcelo L. & Pereira, Fatima R. & Attuy, Guilherme de Moraes, 2013. "Currency Wars in Action: How Foreign Exchange Interventions Work in an Emerging Economy," Insper Working Papers wpe_304, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.

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