Question

You are part of the monetary policy makers in a country facing a depreciation of the home currency. There is consensus for the monetary authority to intervene in the foreign exchange market to strengthen the weak home currency. However, there is debate on whether the intervention must be sterilised or non- sterilised.

Present your points clearly, illustrating with appropriate diagrams the necessary intervention in the forex market, and distinguishing the effects of sterilised from sterilised intervention, and why you prefer the option you will select.

Answer 1

If I am a part of monetary policymaking and my country's currency facing a depreciating issue then it is obvious to intervein in the foreign exchange market to strengthen the weak home currency. There will be two way to strengthen the home currency, 1 sterilized 2.non -sterilized

Both the process are having its own advantages and disadvantages.

1. Sterilized: this a process where two simultaneous processes will be taken place a) purchasing foreign currency to increase the quantity and selling the govt. bond to decrease the supply of home currency. this process is very popularly adopted by china as it is giving importance to export. so if the country is sufficient for export products better to go for a sterilized process which will give a boost to the home currency to keep it away from depreciation. but it associated the risk of losing the value and other inter-country issues.

2. Non-Sterilized: this process central bank refuse to buy or sell asset or currency with a notion of self-correcting mode. so it may take time but this process is risk-free.