Economics Exchange Rate Systems Questions Medium
Sterilized and unsterilized currency intervention are two different approaches used by central banks to influence the exchange rate of their domestic currency.
Sterilized currency intervention refers to a situation where a central bank intervenes in the foreign exchange market by buying or selling its own currency, while simultaneously conducting offsetting transactions in the domestic money market. In this case, the central bank aims to neutralize the impact of its currency intervention on the domestic money supply. For example, if the central bank buys foreign currency, it will sell an equivalent amount of domestic bonds to absorb the excess liquidity created by the intervention. By sterilizing the intervention, the central bank aims to prevent any potential inflationary or deflationary effects on the domestic economy.
On the other hand, unsterilized currency intervention involves direct buying or selling of foreign currency by the central bank without conducting offsetting transactions in the domestic money market. This means that the intervention directly affects the domestic money supply. For instance, if the central bank buys foreign currency, it injects domestic currency into the economy, potentially increasing the money supply. Unsterilized intervention is often used when the central bank wants to actively influence the exchange rate and is willing to accept the potential impact on domestic monetary conditions.
In summary, the main difference between sterilized and unsterilized currency intervention lies in whether the central bank conducts offsetting transactions in the domestic money market to neutralize the impact on the domestic money supply. Sterilized intervention aims to maintain monetary stability, while unsterilized intervention directly affects the domestic money supply and is used when the central bank wants to actively influence the exchange rate.