STERILIZATION, MONETARY POLICY, AND GLOBAL FINANCIAL INTEGRATION Joshua Aizenman
Working Paper 13902
NATIONAL BUREAU OF ECONOMIC RESEARCH
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We thank Michael Hutchinson, Menzie Chinn, an anonymous referee, and participants at the Review of International Economics - Santa Cruz Center for International Economics conference on "Global Liquidity," held at the University of California at Santa Cruz on April 11-12, 2008 for useful comments. We also thank Michael Simmons and Andrew Cohn for research assistance. The views expressed below do not represent those of the Federal Reserve Bank of San Francisco or the Board of Governors of the Federal Reserve System, or the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.
© 2008 by Joshua Aizenman and Reuven Glick. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.
Sterilization, Monetary Policy, and Global Financial Integration Joshua Aizenman and Reuven Glick
NBER Working Paper No. 13902
March 2008, September 2008
JEL No. F15,F21,F31
This paper investigates the changing pattern and efficacy of sterilization within emerging market countries as they liberalize markets and integrate with the world economy. We estimate the marginal propensity to sterilize foreign asset accumulation associated with net balance of payments inflows, across countries and over time. We find that the extent of sterilization of foreign reserve inflows has risen in recent years to varying degrees in Asia as well as in Latin America, consistent with greater concerns about the potential inflationary impact of reserve inflows. We also find that sterilization depends on the composition of balance of payments inflows.
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Economic Research Department
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In the late 1980s and early 1990s, emerging market countries embraced growing financial liberalization and openness. However, by also trying to maintain some degree of both exchange rate stability and monetary independence, many of these countries experienced severe financial crises. In the aftermath of these crises, many emerging markets have adopted a policy configuration involving greater, though still managed, exchange rate flexibility, together with ongoing financial integration and some degree of domestic monetary independence. Hoarding of international reserves has become a key ingredient enhancing the stability of this new pattern. Concerns about the cost of maintaining monetary stability with this new policy mix suggest the need to support hoarding international reserves with more aggressive sterilization. Apprehensions about the opportunity costs of accumulating reserves and the fiscal and distortionary financial costs of sterilization, in turn, have raised questions about the long-run viability of this new policy mix, particularly the efficacy of sterilization. Recent literature has analyzed vary aspects of recent developments, such as the nature and extent of greater exchange rate flexibility, monetary autonomy, and financial integration by emerging market countries (e.g. Fischer 2001, Aizenman and Lee 2008). In this paper we focus on concerns about the extent of sterilization by estimating the marginal propensity to sterilize foreign asset accumulation over time for selected countries in...