Central Bank Monetary Supply Tool – Sterilized Intervention
In short, a Central Bank’s objective is to control ‘monetary policy’. A central bank will have various tools to use at its disposal. Sterilized Intervention is one such tool.
Sterilized intervention is when central bank’s purchase or sell a foreign currency in the foreign exchange market with the aim of influencing the exchange rate of the domestic currency, having no effect on the short-term interest rate.
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If the short-term interest rate is affected by the purchasing or selling of a foreign currency then this would be a non-sterilized intervention or unsterilized intervention.
Central Banks will apply Sterilized Intervention as economic tool. This is because the buying or selling of a foreign currency can affect the nation’s money supply. Selling a foreign currency will reduce the amount of domestic currency and buying will increase the amount of domestic currency.
In order to stop the money supply being affected by the purchase or selling of a currency, there are 2 steps that are taken in a Central Banks Sterilized Intervention. These are:
1) The sale or purchase of foreign exchange reserves.
2) The purchase or sale of securities in the equivalent quantity as the foreign exchange transaction.