Sterilization
Intervention operations involving dollars affect the supply of Federal
Reserve balances to
For example, assume that the Federal Reserve, perhaps in conjunction
with Japanese authorities, wants to counter downward pressure on the dollar’s
foreign exchange value in relation to the Japanese yen. The Federal Reserve
would sell some of its yen denominated securities for yen on the open market and
then trade the yen for dollars in the foreign exchange market, thus reducing
the supply of dollar balances at the Federal Reserve. In order to sterilize the
effect of intervention on the supply of Federal Reserve balances, the Open
Market Desk would then purchase an equal amount of U.S. Treasury securities in
the open market (or arrange a repurchase agreement), thereby raising the supply
of balances back to it’s former level. The net effect of such an intervention is a
reduction in dollar denominated securities in the hands of the public and an
increase in yen denominated securities. The operations have no net effect on the
level of yen balances at the Bank of Japan or on the level of dollar balances at
the Federal Reserve.
A dollar intervention initiated by a foreign central bank also leaves
the supply of balances at the Federal Reserve unaffected, unless the central
bank changes the amount it has on deposit at the Federal Reserve. If, for
example, the foreign central bank purchases dollars in the foreign exchange
market and places them in its account at the Federal Reserve Bank of New York,
then the supply of Federal Reserve balances available to depository institutions
decreases because the dollars are transferred from the bank of the seller of
dollars to the foreign central bank’s account with the Federal Reserve. However,
the Open Market Desk would offset this drain by buying a Treasury security or
arranging a repurchase agreement to increase the supply of Federal Reserve
balances to