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Sterilization costs and exchange rate targeting

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  • Kenneth Kletzer
  • Mark Spiegel

Abstract

This paper examines the movements of exchange rates and capital flows in an environment where an optimizing central bank pursuing the joint goals of inflation and output targeting engages in costly sterilization activities. Our results predict that when faced with increased sterilization costs, the central bank will choose to limit its sterilization activities allowing target variables, such as the nominal exchange rate, to adjust. ; We then test the predictions of a linearized version of the saddle-path solution to the model for a cross-country panel of developing countries. We use IV, GMM and simultaneous equation specifications to allow for the endogeneity of capital inflows. Our results confirm that a monetary policy does respond to sterilization costs.

Suggested Citation

  • Kenneth Kletzer & Mark Spiegel, 1999. "Sterilization costs and exchange rate targeting," Pacific Basin Working Paper Series 99-03, Federal Reserve Bank of San Francisco.
  • Handle: RePEc:fip:fedfpb:99-03
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    Cited by:

    1. David Hauner, 2006. "A Fiscal Price Tag for International Reserves," International Finance, Wiley Blackwell, vol. 9(2), pages 169-195, August.
    2. Julien Pinter, 2017. "Central bank financial strength and inflation: an empirical reassessment considering the key role of the fiscal support," Documents de travail du Centre d'Economie de la Sorbonne 17055, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    3. Li, Jie & Rajan, Ramkishen S., 2006. "Can High Reserves Offset Weak Fundamentals? A Simple Model of Precautionary Demand for Reserves," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 59(3), pages 317-328.
    4. Julien Pinter, 2017. "Central bank financial strength and inflation: an empirical reassessment considering the key role of the fiscal support," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-01660945, HAL.
    5. Ljungwall, Christer & Xiong, Yi & Zou, Yutong, 2009. "Central Bank Financial Strength And The Cost Of Sterilization In China," Working Paper Series 2009-8, Stockholm School of Economics, China Economic Research Center.
    6. Ljungwall, Christer & Xiong, Yi & Yutong, Zou, 2013. "Central bank financial strength and the cost of sterilization in China," China Economic Review, Elsevier, vol. 25(C), pages 105-116.
    7. Menachem Brenner & Meir Sokoler, 2010. "Inflation Targeting and Exchange Rate Regimes: Evidence from the Financial Markets," Review of Finance, European Finance Association, vol. 14(2), pages 295-311.
    8. Bank for International Settlements, 2013. "Central bank finances," BIS Papers, Bank for International Settlements, number 71.

    More about this item

    Keywords

    Foreign exchange ; Capital movements;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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