Understanding Unsterilized Foreign Exchange Intervention: A Comprehensive Guide

What Is an Unsterilized Foreign Exchange Intervention?

The term unsterilized foreign exchange intervention refers to a method where a country’s monetary authorities influence exchange rates and its money supply without conducting offsetting transactions through the purchase or sale of foreign or domestic currencies or assets. This approach is considered passive as it allows for natural fluctuations in the monetary base.

Unsterilized foreign exchange interventions are also known as nonsterilized interventions and can be compared to sterilized interventions, where offsetting measures are taken.

Key Takeaways

• Unsterilized foreign exchange interventions occur when monetary authorities influence exchange rates and the money supply without offsetting transactions to balance the intervention.
• This policy does not involve insulation measures, allowing foreign exchange markets to operate without manipulating the domestic currency supply.
• The monetary base can change as a result, introducing variability into the economy.
• Authorities might use this approach to support or weaken a currency without additional counterbalancing actions.

How Unsterilized Foreign Exchange Interventions Work

Central banks can manipulate a currency’s value by either selling their own reserves to weaken the currency or buying more to strengthen it. Sterilization is a method used to balance this intervention by conducting offsetting transactions, such as selling domestic securities equivalently to the foreign currency purchase, thereby stabilizing the money supply.

Without Sterilization

Unsterilized foreign exchange intervention lacks these insulating measures. When a central bank purposely does not offset the transaction (selling or purchasing currencies or assets), it directly influences the currency’s value, allowing for market-driven changes in the monetary base.

For instance, suppose the Federal Reserve wants to strengthen the Japanese yen. By buying Japanese government bonds without selling U.S. bonds in an equal value on the open market, the intervention remains unsterilized, meaning the Fed’s reserves increase without offsetting the impact, altering the supply-demand balance for the currency.

Unsterilized vs. Sterilized Foreign Exchange Interventions

Authorities use sterilized and unsterilized interventions if they aim to influence exchange rates or the amount of money in circulation. With sterilized interventions, the central bank’s purchase of domestic currency by selling foreign assets passes through offsetting measures, which balances the money supply, removing excess domestic currency from the market.

Conversely, unsterilized interventions do not take such balancing steps. If a currency weakens, the central bank can aim to increase its demand by using foreign reserves to buy its own currency, halting depreciation while adjusting the amount in circulation. Similarly, when a currency sees excessive appreciation, the bank can sell the domestic currency to relieve upward pressure.

Related Terms: sterilized interventions, central banks, monetary base, currency appreciation, currency depreciation

References

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