Financial Markets and Institutions (2-downloads)

foreign assets in the foreign exchange market results in an equal rise in

its international reserves and the monetary base.

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Part 5 Financial Markets

The intervention we have just described, in which a central bank allows the

purchase or sale of domestic currency to have an effect on the monetary base, is

called an unsterilized foreign exchange intervention. But what if the central

bank does not want the purchase or sale of domestic currency to affect the monetary

base? All it has to do is to counter the effect of the foreign exchange intervention

by conducting an offsetting open market operation in the government bond mar-

ket. For example, in the case of a $1 billion purchase of dollars by the Fed and a

corresponding $1 billion sale of foreign assets, which, as we have seen, would

decrease the monetary base by $1 billion, the Fed can conduct an open market pur-

chase of $1 billion of government bonds, which would increase the monetary base

by $1 billion. The resulting T-account for the foreign exchange intervention and the

offsetting open market operation leaves the monetary base unchanged:

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