What is the policy of sterilization? Give an example.

Answer:

• Sterilized foreign exchange intervention – policy by which central banks carry out equal foreign and domestic asset transactions in opposite directions to nullify the impact of foreign exchange operations on domestic money
• Example: Bank of Pecunia sells $100 in foreign assets, receives $100 check from PecuniaCorp. Central foreign assets and liabilities decline simultaneously by $100; fall in money
• To negate effect on money supply, central bank buys $100 of domestic assets. This increases its domestic assets and its liabilities by $100, offsetting the money supply effect of sale of foreign assets.