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EconNet: Banks Make Sterilized FX Purchases Expansionary

Date: 16 Nov 2017

Time: 12:00 PM

Location: 1300 New York Ave., NW, Washington, DC - Room SE-1035, United States


Event open to the public

Title: Banks Make Sterilized FX Purchases Expansionary
Presenter: Marcio Garcia, PUC Rio

Abstract: In the most recent wave of capital inflows, 2009-2012, many emerging markets have resorted to sterilized FX purchases as a way to mitigate exchange rate appreciation. The literature on the effectiveness of sterilized FX interventions to alter the exchange rate is large and inconclusive, but there is scant mention to expansionary effects of FX sterilized purchases other than the effect of possible exchange-rate depreciation on net exports. Nevertheless, many emerging markets’ central banks have complained that the (fully sterilized) capital inflows have fueled large credit expansions, creating credit bubbles and inflation. We show that, indeed, when the banking sector is duly considered, sterilized FX purchases became expansionary, via a credit channel. The mechanism is the following: under massive sterilized FX purchases, the aggregate banking sector balance sheet increases, with the asset side absorbing the bonds used to sterilize the money expansion generated by the sterilized FX purchase. Since interest rate, the return on bonds, does not change, a portfolio balance effect stimulates banks to increase loan supply and lower their augmented bond holdings. Bond sales by the banks, to make cash to increase loans, pressure the interest rate up. To keep the interest rate from rising, the central bank increases money supply. Higher loan supply increases loans and output. In the new equilibrium, the interest rate is kept constant, while the quantity of money and loans increase, as well as output. Recent Brazilian evidence is reviewed, showing that this effect is empirically relevant. Therefore, when considering the banking sector, independently of their effect in preventing nominal appreciation, FX sterilized purchases generally boost credit, activity and inflation. 

Contact information: research@iadb.org

EconNet is the technical seminar series initiative of the Research Department and Knowledge and Learning Sector of the IDB. The series consist of brown-bag seminars at which an invited researcher presents his or her latest research findings on development issues relevant to Latin America and the Caribbean. EconNet takes place every Thursday from 12 noon to 1:30 p.m.

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