Foreign reserve and money dynamics with asset portfolio adjustment: international evidence |
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| Authors: | Reuven Glick Michael M. Hutchison |
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| Affiliation: | 1. RMIT University, Melbourne, Australia;2. College of Accounting, University of Cape Town, South Africa;1. Smith School of Enterprise and Environment, University of Oxford, Hinshelwood Road, Oxford OX1 3QY, UK;2. School of Finance and Management – SOAS University of London, 10 Thornhaugh Street, Russell Square, London WC1H 0XG, UK;3. Department of Banking and Finance, Monash University, Caulfield, VIC 3145, Australia;4. Saïd Business School, Park End Street, Oxford OX1 2BS, UK |
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| Abstract: | In this paper we argue that more complete modeling of foreign exchange intervention and sterilization dynamics is necessary when there are adjustment costs to changing private portfolios and/or the central bank attempts to balance longer-run monetary control against short-term exchange rate objectives. We show that measured correlations between domestic credit and foreign asset changes, often interpreted as ‘sterilization coefficients’, may be misleading because they vary with the pattern of disturbances as well as private agent and central bank behavior. We assess the empirical significance of this issue by estimating vector error correction models of the domestic and foreign asset components of the monetary base for Japan and Germany. In both countries, we find that that the impact of foreign exchange intervention on domestic credit falls markedly after several months, implying that the degree of sterilization decreases over time. However, the monetary base remained largely insulated as foreign asset positions were subsequently ‘unwound.’ |
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| Keywords: | Intervention Sterilization Offset coefficients |
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