Monetary sterilization

Monetary sterilization, in macroeconomics, is a monetary policy measure used by Central Banks so that the entry and exit of capital from a country does not harm its economy.

Monetary sterilization

Sterilization is a monetary policy that is used to compensate the effect of the monetary flows of a country, trying not to alter the monetary mass (total of money) in the face of external changes.

It is done to avoid the appreciation of the country’s currency, to avoid the loss of competitiveness of exports and to combat inflation. It can also be used more aggressively to devalue the currency or fight deflation.

Monetary sterilization example

For example, when a Central Bank observes that the currency of their country is appreciating more than they are interested in. What it will do is act to stop this appreciation, mainly due to the fact that financial markets are selling foreign currency and buying domestic currency.

The Central Bank, to avoid an appreciation of its currency that makes the country’s products more expensive and reduces exports, will intervene in the foreign exchange market by carrying out transactions contrary to those that are occurring naturally in the market. In other words, in this case, the central bank will proceed to buy foreign currency and sell domestic currency. But, to buy that foreign currency you will need money, otherwise it would cause a hole in the balance of payments. The most common is that to finance itself, it issues debt through government bonds. Through this purchase of foreign currency, you are sterilizing the negative effect of the purchase of foreign currency and thus offsetting the balance of payments.

The same is true in the opposite case. When the currency of a country is depreciating, the Central Bank may choose to sell the foreign currencies that it has in its reserves. And so it will try to stop the fall of its currency. To avoid altering the monetary mass of the country, it will carry out a monetary sterilization, going to the open market to spend the money from that sale, buying government bonds and / or bonds of the country’s companies.

Ultimately, sterilization is done to offset the effect of intervention in the foreign exchange market and thus manipulate the exchange rate of the local currency.

Sterilization is done through the purchase or sale of financial assets (buying bonds for example, such as QE). To carry out sterilization, it is necessary for the Central Bank to go to foreign currency markets.