Financial Markets and Institutions (2-downloads)

corresponding sale of foreign assets in the foreign exchange market leads

to an equal decline in its international reserves and the monetary base.

We could have reached the same conclusion by a more direct route. A central

bank sale of a foreign asset is no different from an open market sale of a govern-

ment bond. We learned in our exploration of monetary policy that an open market

sale leads to an equal decline in the monetary base; therefore, a sale of foreign assets

also leads to an equal decline in the monetary base. By similar reasoning, a central

bank purchase of foreign assets paid for by selling domestic currency, like an open

market purchase, leads to an equal rise in the monetary base. Thus, we reach the fol-

lowing conclusion: A central bank’s sale of domestic currency to purchase