Unsterilized Foreign Exchange Intervention Definition

What is an unsterilized exchange intervention?

The term unsterilized foreign exchange intervention refers to the way a country’s monetary authorities influence exchange rates and its money income—by not buying foreign currency or selling foreign currency or domestic assets. This type of approach is considered passive exchange rate fluctuations, taking into account fluctuations in the monetary base.

Unsterilized exchange interventions are also called unsterilized interventions and can be compared to sterilized interventions.

Key points to remember

  • Unsterilized foreign exchange interventions take place when a country’s monetary authorities influence exchange rates and its money supply.
  • This policy takes place when a central bank does not offset the purchase or sale of foreign or domestic currency or assets with another transaction.
  • When central banks implement unsterilized foreign exchange intervention, they do not put in place insulation measures.
  • Unsterilized interventions allow foreign exchange markets to operate without manipulating the domestic money supply, so a country’s monetary base can change.

How Unsterilized Foreign Exchange Interventions Work

Central banks can weaken a currency by selling their own reserves in the market. They can also strengthen it by buying more and selling their own currency. Sterilization occurs when authorities offset the purchase of foreign currency or securities by selling domestic currency, thereby dropping its own money supply. Central banks use sterilization as a way to insulate or protect their economies from any negative impact of things like currency appreciation or inflation, both of which can reduce a country’s export competitiveness in the world market.

Sterilization can be used to insulate or protect economies from any negative impact of currency appreciation or inflation

When central banks implement unsterilized foreign exchange intervention, they do not put in place insulation measures. Therefore, the transaction is one-sided: only the purchase or sale of currencies or assets– without being compensated. The policy allows foreign exchange markets to operate without manipulating the domestic money supply. This means that a country monetary base is allowed to change.

For example, the Federal Reserve can decide to reinforce japanese yen by buying Japanese government bonds, increasing its own reserves of the foreign country’s assets. Intervention is unsterilized if the Fed decides not to sell its own bonds as reserves on the open market.

Unsterilized vs Sterilized Foreign Exchange Interventions

As stated above, central bank authorities use sterilized and unsterilized methods of exchange intervention when and if they want to influence exchange rates and/or money supply. If the central bank buys national currency by selling foreign assets, the money supply contracts because it has taken the national currency out of the market. This is an example of a sterilized policy.

If the value of a currency begins to weaken in the world market, the central bank of that country can intervene and attempt to influence the exchange rate by creating a demand for the currency. The bank can buy its own currency using the foreign currency it has in its own reserves. It not only cuts the currency depreciation, but also controls the money supply by reducing the amount in circulation. The same is true if the central bank decides to do the opposite, selling its own currency if it appreciates too much.