Sterilized Intervention

AAA

DEFINITION of 'Sterilized Intervention'

The purchase or sale of foreign currency by a central bank to influence the exchange value of the domestic currency, without changing the monetary base. Sterilized intervention involves two separate transactions: 1) the sale or purchase of foreign currency assets, and 2) an open market operation involving the purchase or sale of U.S. government securities (in the same size as the first transaction). The open market operation effectively offsets or sterilizes the impact of the intervention on the monetary base. If the sale or purchase of the foreign currency is not accompanied by an open market operation, it would amount to an unsterilized intervention. Empirical evidence suggests that sterilized intervention is generally incapable of altering exchange rates.

INVESTOPEDIA EXPLAINS 'Sterilized Intervention'

Consider a simple example of sterilized intervention. Assume that the Federal Reserve is concerned about the weakness of the dollar against the euro. It therefore sells euro-denominated bonds in the amount of EUR 10 billion, and it receives $14 billion in proceeds from the bond sale. Since the withdrawal of $14 billion from the banking system to the Federal Reserve would affect the federal funds rate, the Federal Reserve will immediately conduct an open market operation and buy $14 billion of U.S. Treasuries. This injects the $14 billion back into the monetary system, sterilizing the sale of the euro-denominated bonds. The Federal Reserve in effect also shuffles its bond portfolio by exchanging euro-denominated bonds for U.S. Treasuries.

The U.S. Treasury department is responsible for determining the nation’s exchange rate, and for that purpose, it maintains the Exchange Stabilization Fund, which is a portfolio of foreign currency and dollar-denominated assets. The Federal Reserve also has a foreign currency portfolio for the same purpose. Exchange rate intervention is carried out jointly by the Treasury and Federal Reserve.

One of the main tools used by the Federal Reserve to influence monetary policy is its target for the federal funds rate, which is set by the Federal Open Market Committee primarily to achieve domestic objectives. Since the Federal Reserve would never permit its intervention activities to have an impact on its monetary policy operations, it always uses sterilized intervention. Central banks of major nations – such as the Bank of Japan and the European Central Bank – which also use an overnight interest rate as a short-term operating target, likewise sterilize their currency interventions.

RELATED TERMS
  1. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  2. Currency Exchange

    A business that allows customers to exchange one currency for ...
  3. Digital Currency Exchanger - DCE

    A market maker who exchanges legal tender for electronic currency, ...
  4. Foreign Exchange Intervention

    A monetary policy tool in which a central bank takes an active ...
  5. Currency

    A generally accepted form of money, including coins and paper ...
  6. Central Bank

    The entity responsible for overseeing the monetary system for ...
RELATED FAQS
  1. What is the difference between consumer surplus and economic surplus?

    The consumer surplus is the difference between the highest price a consumer is willing to pay and the actual market price ... Read Full Answer >>
  2. What does it signify about a given product if the consumer surplus figure for that ...

    High consumer surplus for a particular product signifies a high level of utility for consumers and may carry some implications ... Read Full Answer >>
  3. How does the balance of trade impact currency exchange rates?

    The balance of trade influences currency exchange rates through its effect on the supply and demand for foreign exchange. ... Read Full Answer >>
  4. How does the balance of trade impact a nation's capital accounts balance?

    The balance of trade doesn't necessarily impact the capital account balance, but the two are very much related. A nation's ... Read Full Answer >>
  5. How do I calculate the production possibility frontier in Excel?

    The production possibility frontier is actually a data set of values that produce a curve expressing opportunity cost on ... Read Full Answer >>
  6. Why do supply shocks occur and who do they negatively affect the most?

    The exact nature and cause of supply shocks is imperfectly understood. The most common explanation is that an unexpected ... Read Full Answer >>
Related Articles
  1. Economics

    7 Misconceptions About The Federal Reserve

    There are many fallacies about the Fed. The following misconceptions are among the most popular.
  2. Bonds & Fixed Income

    The Treasury And The Federal Reserve

    Find out how these two agencies create policies to stimulate the economy in tough economic times.
  3. Forex Education

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  4. Personal Finance

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  5. Personal Finance

    How The Federal Reserve Manages Money Supply

    Find out how the Fed manages bank reserves and this contributes to a stable economy.
  6. Personal Finance

    How The Federal Reserve Was Formed

    Find out how this institution has stabilized the U.S. economy during economic downturn.
  7. Economics

    When The Federal Reserve Intervenes (And Why)

    The Federal Reserve doesn't interfere with the economy every time it flounders. Find out more here.
  8. Forex Education

    Dual And Multiple Exchange Rates 101

    Why would a country choose to implement dual or multiple exchange rates? It's risky, but it can work.
  9. Fundamental Analysis

    Understanding The Federal Reserve Balance Sheet

    We are all connected to the Fed's balance sheet, and the currency notes that we hold are its liabilities.
  10. Personal Finance

    What Are Central Banks?

    They print money, they control inflation, and much, much more. All you need to know about central banks is here.

You May Also Like

Hot Definitions
  1. Fixed-Income Arbitrage

    An investment strategy that attempts to profit from arbitrage opportunities in interest rate securities. When using a fixed-income ...
  2. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  3. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  4. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
  5. Unsystematic Risk

    Company or industry specific risk that is inherent in each investment. The amount of unsystematic risk can be reduced through ...
  6. Security Market Line - SML

    A line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky ...
Trading Center