Offset and Sterilization Under Fixed Exchange Rates with an Optimizing Central Bank

37 Pages Posted: 19 Jun 2004 Last revised: 8 Aug 2010

See all articles by Nouriel Roubini

Nouriel Roubini

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: November 1988

Abstract

The traditional approach to the estimation of the offset and sterilization equations can be criticized for the ad-hoc specification of the reaction function of the monetary authorities and the endogeneity of the domestic credit and foreign reserve variables in the estimated equations. The paper proposes an alternative analytical model where the sterilization and offset equations are derived from an explicit maximization problem solved by the monetary authority. In such a model, the optimal intervention and sterilization policies of the monetary authority are shown to be dependent on the different disturbances hitting the economy and the preferences of the monetary authority. In particular, under a wide range of domestic and foreign disturbances the optimal response of the central bank will lead to negatively correlated comovements of domestic credit and foreign reserves if the cer1tral bank cares more about the interest rate smoothing objective relative to the foreign exchange reserve stabilization goal. Conversely, positive correlations between domestic credit and foreign reserves will be observed if the foreign reserve objective is dominant.

Suggested Citation

Roubini, Nouriel, Offset and Sterilization Under Fixed Exchange Rates with an Optimizing Central Bank (November 1988). NBER Working Paper No. w2777. Available at SSRN: https://ssrn.com/abstract=226861

Nouriel Roubini (Contact Author)

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