Author Question: Assuming perfect asset substitutability, can sterilized intervention by the central bank be ... (Read 75 times)

plus1 · **on:** Jun 30, 2018

Assuming perfect asset substitutability, can sterilized intervention by the central bank be effective? Please discuss.

What will be an ideal response?

Question 2

In the specific factors model, a 0 increase in the price of food accompanied by a 5 increase in the price of cloth will cause wages to ________, the production of cloth to ________, and the production of food to ________.

A) increase by less then 5; increase; decrease
B) increase by 5; remain unchanged; remain unchanged
C) increase by more then 5; increase; remain unchanged
D) remain constant; increase; increase
E) remain constant; decrease; decrease

djofnc · **Reply #1 on:** Jun 30, 2018

Answer to Question 1

No, a sterilized foreign exchange intervention by the central bank leaves the domestic money supply unchanged. Under floating exchange rates, a change in the interest rate is needed to affect the exchange rate, but the interest rate won't change if the money supply does not. Under a fixed exchange rate, an expansive policy needs to be offset by an increase in the domestic money supply. To avoid inflation, the central bank sterilizes this increase in the money supply by selling domestic assets. However, with a fixed exchange rate, this means buying foreign assets. If foreign assets are perfect substitutes for domestic assets, this sterilization is not effective.

Answer to Question 2

A