ECON 310 009 Money & Banking J. Scott Sperling
Foreign Exchange Intervention†
Central banks engage in international transactions by buying foreign denominated assets and
selling their currency or by selling foreign assets (from their international reserves) and purchasing
the domestic currency. These activities can affect the exchange rate.
0.1 Unsterilized Foreign Exchange Intervention
When the central bank sells foreign assets, it said to be purchasing the domestic currency, and the
purchaser of the asset has to pay the central bank with either currency or domestic deposits. In
either case, this decreases the monetary base by the amount of the transaction. The appreciation
of the domestic currency causes the exchagne rate to increase. Conversely, the central bank can
sell the domestic currency by purchasing foreign assets which increases the monetary base, the
domestic currency depreciates and the exchange rate declines (see Figure 1 on p. 482 of your text).
0.2 Sterilized Intervention
The central bank can offset its international transaction with an offsetting open market operation.
In this case the monetary base and money supply remain unchanges, so there is no change in
exchange rates.
†If you find any errors or have any questions about these notes, please email me at [email protected].