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Sterilization and Monetary Control under Pegged Exchange Rates: Theory and Evidence


  • Michael R. Darby


In veiw of recent strong evidence that substantial sterilization of the monetary effects of reserve flows occurs, a modified monetary approach model is formulated in which central banks exercise no control over their domestic money supply despite their sterilization activities. This model is compared with a more general model in which the balance of payments and domestic money supply are both influenced by the central bank's domestic policy goals. In order for the central bank to exercise monetary control, three conditions must be met: assets are not perfect substitutes, goods are not perfect substitutes, and expected depreciation is not "too -responsive" to the balance of payments. The third condition may be met for small but not large reserve flows. Reduced form tests are derived which show for Canada, France, Germany, Italy, Japan, th Netherlands, and the United Kingdom that domestic policy goals strongly influenced quarterly changes in the domestic money supply; this strongly contradicts both the modified and standard monetary approach to the balance of payments. Thus there is a relevant "short-run" in which monetary authorities exercise monetary control. The paper concludes that the simpler monetary approach is no longer empirically tenable for analysis of quarterly data and that more general simultaneous models must be specified and tested.

Suggested Citation

  • Michael R. Darby, 1980. "Sterilization and Monetary Control under Pegged Exchange Rates: Theory and Evidence," NBER Working Papers 0449, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:0449
    Note: ITI IFM

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    References listed on IDEAS

    1. Boyer, Russel S., 1979. "Sterilization and the monetary approach to balance of payments analysis," Journal of Monetary Economics, Elsevier, vol. 5(2), pages 295-300, April.
    2. Gregory C. Chow, 1966. "On the Long-Run and Short-Run Demand for Money," Journal of Political Economy, University of Chicago Press, vol. 74, pages 111-111.
    3. Michael R. Darby & Alan C. Stockman, 1980. "The Mark III International Transmission Model," NBER Working Papers 0462, National Bureau of Economic Research, Inc.
    4. Blejer, Mario I., 1979. "On causality and the monetary approach to the balance of payments : The European experience," European Economic Review, Elsevier, vol. 12(3), pages 289-296, July.
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    Cited by:

    1. Daniel M. Laskar, 1983. "Short-Run Independence of Monetary Policy under a Pegged Exchange-Rates System: An Econometric Approach," NBER Chapters,in: The International Transmission of Inflation, pages 314-348 National Bureau of Economic Research, Inc.
    2. Dan Lee, 1983. "Effects of Open Market Operations and Foreign Exchange Market Operations under Flexible Exchange Rates," NBER Chapters,in: The International Transmission of Inflation, pages 349-379 National Bureau of Economic Research, Inc.
    3. Richard Portes, 1981. "Central Planning and Monetarism: Fellow Travelers?," NBER Working Papers 0782, National Bureau of Economic Research, Inc.
    4. Charles Pigott, 1980. "Expectations, money, and the forecasting of inflation," Economic Review, Federal Reserve Bank of San Francisco, issue Spr, pages 30-49.

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