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Can Sterilized FX Purchases under Inflation Targeting be Expansionary?

Author

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  • MArcio Gomes Pinto Garcia

    (Department of Economics PUC-Rio)

Abstract
Unlike common wisdom, sterilized FX purchases under inflation targeting, i.e., those that keep the interest rate at the level targeted by the central bank, generally increase aggregate demand. We resort to a simple model with a credit channel to argue that FX purchases, by funding bank credit, end up increasing aggregate and money demand, while expanding loans and reducing the loan interest rate. Therefore, restoring the interest rate to the level previous to the FX purchase may not be sufficient to avoid the expansionary effect; the new money market equilibrium, at the same interest rate, will entail a larger money supply, higher output and larger money demand. Recent Brazilian evidence is reviewed, showing that this effect may be empirically relevant. If this is the case, inflation targeters may have another reason to be concerned when conducting FX sterilized interventions, besides their high cost and controversial effectiveness in preventing nominal appreciation. FX sterilized purchases may not only fail to prevent nominal appreciation, but also boost activity and inflation, thereby appreciating the real exchange rate.

Suggested Citation

  • MArcio Gomes Pinto Garcia, 2011. "Can Sterilized FX Purchases under Inflation Targeting be Expansionary?," Textos para discussão 589, Department of Economics PUC-Rio (Brazil).
    • Handle: RePEc:rio:texdis:589
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    Cited by:

    1. Hernando Vargas & Andrés González & Diego Rodríguez, 2013. "Foreign exchange intervention in Colombia," BIS Papers chapters, in: Bank for International Settlements (ed.), Sovereign risk: a world without risk-free assets?, volume 73, pages 95-125, Bank for International Settlements.
    2. Agostini & Luciano Luiz Manarin Dagostini & Jose Luis Oreiro, 2018. "Terms Of Trade, Real Exchange Rate Over-Valuation And De-Industrialization: Theory And Empirical Evidence On Brazilian Case (2003-2015)," Anais do XLIV Encontro Nacional de Economia [Proceedings of the 44th Brazilian Economics Meeting] 53, ANPEC - Associação Nacional dos Centros de Pós-Graduação em Economia [Brazilian Association of Graduate Programs in Economics].
    3. Canuto, Otaviano, 2011. "How Complementary Are Prudential Regulation and Monetary Policy?," World Bank - Economic Premise, The World Bank, issue 60, pages 1-7, June.
    4. Moura, Marcelo L. & Pereira, Fatima R. & Attuy, Guilherme de Moraes, 2013. "Currency Wars in Action: How Foreign Exchange Interventions Work in an Emerging Economy," Insper Working Papers wpe_304, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
    5. Shin, H.S. & Turner, P., 2015. "What does the new face of international financial intermediation mean for emerging market economies?," Financial Stability Review, Banque de France, issue 19, pages 25-36, April.
    6. Bayoumi, Tamim & Saborowski, Christian, 2014. "Accounting for reserves," Journal of International Money and Finance, Elsevier, vol. 41(C), pages 1-29.
    7. Philip Turner, 2016. "Macroprudential policies, the long-term interest rate and the exchange rate," BIS Working Papers 588, Bank for International Settlements.
    8. Canuto, Otaviano & Cavallari, Matheus, 2013. "Monetary policy and macroprudential regulation : whither emerging markets," Policy Research Working Paper Series 6310, The World Bank.
    9. Jhuvesh Sobrun & Philip Turner, 2015. "Bond markets and monetary policy dilemmas for the emerging markets," BIS Working Papers 508, Bank for International Settlements.

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