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Exchange rates, inflation, and the sterilization problem: Germany, 1975-1981

  • Obstfeld, Maurice

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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Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 21 (1983)
Issue (Month): 1-2 ()
Pages: 161-189

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Handle: RePEc:eee:eecrev:v:21:y:1983:i:1-2:p:161-189
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  1. Maurice Obstfeld, 1980. "Imperfect Asset Substitutability and Monetary Policy under Fixed Exchange Rates," NBER Working Papers 0485, National Bureau of Economic Research, Inc.
  2. 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.
  3. 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.
  4. 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.
  5. Jeffrey A. Frankel, 1981. "Estimation of portfolio-balance functions that are mean-variance optimizing: the mark and the dollar," International Finance Discussion Papers 188, Board of Governors of the Federal Reserve System (U.S.).
  6. 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.
  7. Frankel, Jeffrey A., 1979. "The diversifiability of exchange risk," Journal of International Economics, Elsevier, vol. 9(3), pages 379-393, August.
  8. Stulz, ReneM., 1982. "The forward exchange rate and macroeconomics," Journal of International Economics, Elsevier, vol. 12(3-4), pages 285-299, May.
  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, 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. 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.
  12. 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.
  13. Hodrick, Robert J., 1981. "International asset pricing with time-varying risk premia," Journal of International Economics, Elsevier, vol. 11(4), pages 573-587, November.
  14. 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.
  15. Henderson, Dale W, 1979. "Financial Policies in Open Economies," American Economic Review, American Economic Association, vol. 69(2), pages 232-39, May.
  16. 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..
  17. 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.
  18. 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.
  19. John R. Martin & Paul R. Masson, 1979. "Exchange Rates and Portfolio Balance," NBER Working Papers 0377, National Bureau of Economic Research, Inc.
  20. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  21. Michael R. Darby & Alan C. Stockman, 1980. "The Mark III International Transmission Model," NBER Working Papers 0462, National Bureau of Economic Research, Inc.
  22. 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.
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