Sterilized intervention is an action by the central bank to buy or sell foreign currency to change the value of the local currency against the currencies of other countries without changing monetary policy. For its implementation, the Central Bank has two ways, namely: First, buying or selling assets denominated in foreign currencies. Second, carry out market operations of buying or selling domestic bonds in accordance with the amount obtained in the first step.
Now, the central bank is the institution in charge of determining the monetary policy of a country, but often a phenomenon does not have to be solved by making a new monetary policy. For example, one day the officials of the Central Bank of America or the Fed saw that the value of the US Dollar had weakened too deeply against the Pound sterling currency because the GBPUSD pair formed a bullish trend that was too high. This made them take the initiative to take several steps so that the US Dollar could strengthen against the Pound sterling without changing the current monetary policy, such as changing interest rates.
What needs to be understood is that when the US Dollar weakens too deeply against the Pound sterling, it means that the demand for the Pound sterling is greater than the demand for the US Dollar. So that the Sterilized Intervention was carried out which could make the demand for the US Dollar higher than before, as follows:
Incidentally, the Fed has been keeping British government bonds denominated in Pounds Sterling of 30 billion Pounds Sterling, so the first step was to sell 30 billion Pounds of the bonds according to the GBPUSD exchange rate of $1.29. From the sale of these bonds, the Fed received funds of $38.700 million.
After completing the first step and obtaining $38.700 million in funds, the second step was carried out, namely market operations to buy United States government bonds according to the amount from the sale of British government bonds.
The effect of this action is to increase the amount of demand for US Dollars by buying US government bonds worth $38.700 million. So slowly the price in the GBPUSD pair will form a bearish trend which means the US Dollar begins to strengthen against the Pound sterling.
Problems from Sterilized Intervention
From the example above, the sterilized intervention occurred due to the weakening of the US Dollar value against the Pound Sterling, so this step was taken to make the US Dollar value stronger against the GBP. Now the problem is that sterilized intervention will not be able to make a currency strengthen in the long term and tends to only result in the correction of a trend. So that many economists see that this action is less effective and ultimately more effective to make the currency strengthen is to increase interest rates and strengthen the country’s economy.
But on the other hand, when the Central Bank changes interest rates too often to keep the currency value stable, it will disrupt the banking system and commercial banks have a little difficulty in determining loan interest rates and deposit rates. That’s why a central bank is still carrying out sterilized intervention to keep the value of its currency stable against the value of other countries’ currencies without having to change interest rates too often.
Sterilized intervention is a foreign exchange market activity in which monetary authorities isolate their domestic money supply from foreign exchange transactions by offsetting the sale or purchase of domestic assets.
Sterilized Intervention also refers to the buying or selling of foreign exchange by the central bank in the market. its purpose is to influence the exchange rate. If the measure has no effect on short-term interest rates, it is a sterilized intervention. If short-term interest rates change as a result of the action, it is an unsterilized intervention or an unsterilized intervention.
When a central bank buys or sells a portion of its foreign currency reserves, the country’s money supply may be affected. Selling foreign currency reserves reduces the supply of domestic currency, while buying reserves increases the money supply.
The central bank can cancel – sterilize – the effect on the money supply or monetary base caused by the purchase or sale of foreign exchange reserves by buying or selling equivalent amounts of securities.
If reserves are increased by buying foreign currency, there will be an increase in the money supply, unless the government sells Treasury bills (short-term promissory notes) or some other type of domestic security to clean up the additional demand generated.
The Danish central bank said that in practice, the majority of central banks currently apply short-term interest rates as their operational targets or monetary policy instruments. Therefore, whether intervention in the foreign exchange market is sterilized or not, is usually judged on what impact it has on money market interest rates.
Sterilized Intervention has an impact on falling currencies
Imagine a country’s currency loses value and then depreciates. Its central bank may decide to intervene in the foreign exchange market by creating artificial demand for its domestic currency.
This can be achieved by using some of the central bank’s foreign exchange reserves to buy the local currency. The resulting demand stops the currency from falling. however, it also reduces the money supply in two ways:
The central bank directly removes some of the economy’s currency from circulation.
If targets are exceeded by the central bank, its intervention could create current account deficits or exacerbate existing deficits – as a sustained exchange rate makes imports cheaper and exports more expensive. This deficit sends more of the domestic currency overseas, which further reduces liquidity.
The resulting fall in the money supply may have an unintended deflationary effect, especially if the unemployment rate is currently high
Talking about sterilized intervention cannot be separated from unsterilized interventions or unsterile interventions. Sterilized interventions are a continuation of unsterilized interventions in which the central bank buys or sells foreign currency securities using the domestic currency.
Unsterilized interventions that will leave the effect of excess currency securities in the central bank. To clean up the effects of these interventions, sterile interventions are carried out with reference to the actions taken when carrying out unsterilized interventions.
If unsterilized interventions are carried out by the central bank by buying foreign currency securities, then sterilized interventions are carried out by selling domestic currency securities.
Conversely, if in unsterilized interventions the central bank sells foreign currency securities, sterilized interventions are carried out by buying domestic currency securities.
