Unsterilized Foreign Exchange Intervention

Unsterilized Foreign Exchange Intervention refers to the intervention of central banks in the foreign exchange market as part of their monetary policy. In these interventions, the central bank becomes an active player in the foreign exchange market by buying or selling domestic currency.

When these interventions are unsterilized, the central bank increases its foreign exchange reserves by buying domestic currency, while also increasing the domestic money supply. This can result in a decrease in the value of the domestic currency and an increase in the exchange rate.

Unsterilized Foreign Exchange Intervention is typically used to prevent the overvaluation of the domestic currency or to protect the domestic economy against external shocks. For example, a central bank may intervene in the foreign exchange market and buy domestic currency to create pressure on the exchange rate in order to maintain the competitiveness of exports.

However, unsterilized interventions come with certain risks. The depreciation of the domestic currency can lead to an increase in the cost of imported goods and higher inflation. Additionally, increasing foreign exchange reserves can expand the central bank’s balance sheet and affect financial stability.

Therefore, central banks generally prefer sterilized interventions. In sterilized interventions, the central bank buys domestic currency while withdrawing an equal amount of domestic currency from the market to keep the money supply constant. This creates an impact on the exchange rate without affecting the domestic money supply.

Unsterilized Foreign Exchange Intervention is a tool used by central banks as part of their monetary policy. However, it should be carefully evaluated and used in conjunction with other monetary policy tools to be effective.