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Offset and Sterilization Under Fixed Exchange Rates With An Optimizing Central Bank


  • Nouriel Roubini


The traditional approach to the estimation of the offset and sterilization equations can be criticized for the ad-hoc specification of the reaction function of the monetary authorities and the endogeneity of the domestic credit and foreign reserve variables in the estimated equations. The paper proposes an alternative analytical model where the sterilization and offset equations are derived from an explicit maximization problem solved by the monetary authority. In such a model, the optimal intervention and sterilization policies of the monetary authority are shown to be dependent on the different disturbances hitting the economy and the preferences of the monetary authority. In particular, under a wide range of domestic and foreign disturbances the optimal response of the central bank will lead to negatively correlated comovements of domestic credit and foreign reserves if the cer1tral bank cares more about the interest rate smoothing objective relative to the foreign exchange reserve stabilization goal. Conversely, positive correlations between domestic credit and foreign reserves will be observed if the foreign reserve objective is dominant.

Suggested Citation

  • Nouriel Roubini, 1988. "Offset and Sterilization Under Fixed Exchange Rates With An Optimizing Central Bank," NBER Working Papers 2777, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2777
    Note: ITI IFM

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    References listed on IDEAS

    1. Neumann, Manfred J. M., 1978. "Offsetting capital flows : A reexamination of the German case," Journal of Monetary Economics, Elsevier, vol. 4(1), pages 131-142, January.
    2. Vaubel, Roland, 1980. "The return to the new european monetary system : Objectives, incentives, perspectives," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 13(1), pages 173-221, January.
    3. 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 443-467, May/June.
    4. 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.
    5. Robert J. Barro, 1988. "Interest-Rate Smoothing," NBER Working Papers 2581, National Bureau of Economic Research, Inc.
    6. Aoki, Masanao, 1977. "A note on the stability of the interaction of monetary policies," Journal of International Economics, Elsevier, vol. 7(1), pages 81-94, February.
    7. Marston, Richard C., 1980. "Cross country effects of sterilization, reserve currencies, and foreign exchange intervention," Journal of International Economics, Elsevier, vol. 10(1), pages 63-78, February.
    8. Kouri, Pentti J. K., 1975. "The hypothesis of offsetting capital flows : A case study of Germany," Journal of Monetary Economics, Elsevier, vol. 1(1), pages 21-39, January.
    9. Obstfeld, Maurice, 1982. "Can We Sterilize? Theory and Evidence," American Economic Review, American Economic Association, vol. 72(2), pages 45-50, May.
    10. Neumann, Manfred J. M., 1984. "Intervention in the mark/dollar market: the authorities' reaction function," Journal of International Money and Finance, Elsevier, vol. 3(2), pages 223-239, August.
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    Cited by:

    1. Buch, Claudia M. & Lusinyan, Lusine & Engerer, Hella & Lodahl, Maria & Schrettl, Wolfram & Schrooten, Mechthild, 2000. "Russlands Wirtschaftspolitik setzt auf Investitionen," Kiel Discussion Papers 360, Kiel Institute for the World Economy (IfW).
    2. M. Buch, Claudia & Hanschel, Elke, 2000. "The Effectiveness of Capital Controls: The Case of Slovenia," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 15, pages 602-628.
    3. Kletzer, Kenneth & Spiegel, Mark M., 2004. "Sterilization costs and exchange rate targeting," Journal of International Money and Finance, Elsevier, vol. 23(6), pages 897-915, October.
    4. Caprio, Gerard & Honohan, Patrick, 1990. "Monetary policy instruments for developing countries," Policy Research Working Paper Series 528, The World Bank.
    5. Eichengreen, Barry, 1989. "International Monetary Istability Between the Wars: Structural Flaws or Misguided Policies?," Department of Economics, Working Paper Series qt5r60q801, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    6. repec:onb:oenbwp:y::i:20:b:1 is not listed on IDEAS
    7. Igor Ljubaj & Ana Martinis & Marko Mrkalj, 2010. "Capital Inflows and Efficiency of Sterilisation – Estimation of Sterilisation and Offset Coefficients," Working Papers 24, The Croatian National Bank, Croatia.
    8. Mark P. Taylor & Lucio Sarno, 2001. "Official Intervention in the Foreign Exchange Market: Is It Effective and, If So, How Does It Work?," Journal of Economic Literature, American Economic Association, vol. 39(3), pages 839-868, September.
    9. Gyuhan Kim, 1995. "Exchange rate constraints and money control in Korea," Working Papers 1995-011, Federal Reserve Bank of St. Louis.
    10. Johannes Groeneveld, 1998. "From the ERM with Love: Monetary Spillover Effects to Austria," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 25(3), pages 331-345, January.
    11. Hans Groeneveld, 1995. "Monetary Spill-over Effects in the ERM: The Case of Austria, a Former Shadow Member," Working Papers 20, Oesterreichische Nationalbank (Austrian Central Bank).

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