Sterilization Costs and Exchange Rate Targeting

30 Pages Posted: 24 Oct 2008

See all articles by Kenneth M. Kletzer

Kenneth M. Kletzer

University of California at Santa Cruz; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Mark M. Spiegel

Federal Reserve Bank of San Francisco - Economic Research Department

Date Written: April 3, 2000

Abstract

This paper examines the movements of exchange rates and capital inflows in an environment where an optimizing central bank pursuing the joint goals of inflation and output targeting engages in costly sterilization activities. Our results predict that when faced with increased sterilization costs, the central bank will choose to limit its sterilization activities allowing target variables, such as the nominal exchange rate, to adjust.

We then test the predictions of a linearized version of the saddle-path solution to the model for a cross-country panel of developing countries. We use IV, GMM and simultaneous equation specifications to allow for the endogeneity of capital inflows. Our results confirm that monetary policy does respond to sterilization costs.

Keywords: Sterilization, capital inflows, exchange rates

JEL Classification: F32

Suggested Citation

Kletzer, Kenneth M. and Spiegel, Mark M., Sterilization Costs and Exchange Rate Targeting (April 3, 2000). Available at SSRN: https://ssrn.com/abstract=1288211 or http://dx.doi.org/10.2139/ssrn.1288211

Kenneth M. Kletzer (Contact Author)

University of California at Santa Cruz ( email )

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Mark M. Spiegel

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