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.
Sterilization is a monetary policy that is used to compensate for the effect of a country’s monetary flows, ensuring that the monetary mass (total money) is not altered by external changes.
It is done to avoid the appreciation of the country’s currency, to avoid the loss of competitiveness of exports and to fight inflation . It can also be used more aggressively to devalue the currency or fight deflation .
Example of monetary sterilization
For example, when a Central Bank observes that its country’s currency is appreciating more than they are interested in. What it will do is act to curb that appreciation, mainly because financial markets are selling foreign currency and buying national 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 naturally occurring in the market. That is, in this case, the central bank will proceed to buy foreign currency and sell national 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 issue debt through government bonds . Through this purchase of foreign currency you are sterilizing the negative effect of the purchase of foreign currency and thus compensating the balance of payments.
The same happens in the opposite case. When a country’s currency is depreciating, the Central Bank may choose to sell the foreign currencies it has in its reserves. And so he will try to stop the fall of his currency. To avoid altering the country’s monetary mass, 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.
In short, sterilization is done to compensate for the effect of intervention in the foreign exchange market and thus manipulate the exchange rate of the local currency.
Sterilization is done by buying or selling financial assets (buying bonds for example, such as QE ). To perform sterilization, it is necessary that the Central Bank go to foreign currency markets.