A central bank can sterilize the increase in the money supply that results from an intervention to defend a fixed exchange rate by selling domestic government bonds.

Question

Quizplus · Accepted Answer

When a central bank intervenes to defend a fixed exchange rate, it typically purchases foreign currency, which increases the supply of domestic currency in circulation. If left unchecked, this can lead to inflation. To prevent this, the central bank can sell domestic government bonds to absorb the excess domestic currency and maintain the fixed exchange rate. This process is known as sterilization.

A Central Bank Can Sterilize the Increase in the Money