How effective are sterilized foreign exchange purchases by central banks (foreign exchange purchases in which the central bank reabsorbs the additional liquidity through counteroperations so that the amount of central bank reserves remains unchanged) in times of very low interest rates? Dr. Markus Hertrich, Professor of International Economics at htw saar, and Dr. Daniel Nathan, Assistant Professor of Finance at Hong Kong Polytechnic University, address this question in a recent article in the Journal of Money, Credit and Banking, one of the leading international journals for economics and financial economics.
The study analyzes the Israeli central bank's US dollar purchases between 2013 and 2019 based on confidential daily data. The key finding: a purchase of US$1 billion led to an average depreciation of the Israeli shekel by around 0.8 percent – a remarkably significant effect by international standards.
Furthermore, the study shows that the effectiveness of such measures is closely linked to the structures of the financial markets. In particular, the limited risk-bearing capacity of global banks contributes to interventions having a lasting effect on the foreign exchange market, as market players are then only able to take limited action against the interventions. In addition to their direct effect on the exchange rate, the measures also have an impact on futures and options markets by changing expectations about future exchange rates and the associated risks.
The results provide important insights for small, open economies that want to secure their monetary policy leeway in a persistent low interest rate environment.