Sterilization of capital inflows: Its impact on market liquidity and currency crises.

다국어 초록 (Multilingual Abstract)

During the first part of the 90's most of the emerging economies experienced strong capital inflows, as a result of various external and internal factors. Most of these economies operated at the time under fixed exchange regimes, and the capital inflows raised the concerns that these flows could generate inflationary pressure, and the potential destabilization of the fixed exchange regime. In order to control for this effect, numerous countries adopted sterilization policies, mainly in the form of open market operation.
The present work aims to develop a theoretical analysis to evaluate the effectiveness and market impact of this type of monetary policies, using a portfolio allocation model that incorporates an innovative liquidity-in-advance restriction to derive the demand for assets of different maturity structure. The analysis developed up to now raises the concern that this kind of intervention, under certain circumstances, might have a negative impact on the stability of a fixed currency regime. The general conjecture of the model is that, by issuing short-term public bonds to absorb domestic credit and to sterilize capital inflows, the monetary authorities affect not just the currency composition, but also the maturity structure of private agent's portfolio. This portfolio effect implies the possible increase in the liquidity of the market, and the consequent increase in the vulnerability of the system to speculative attacks. The model derives the policy implication that under certain circumstances, sterilization operations realized through highly liquid instruments, although conceived as a mechanism oriented to stabilize the market, might turn out to be a self-defeating policy.