Capital Flows, Measures and Effectiveness of Monetary Sterilization Policies in the Selected Emerging Market Economies

Year 2025, Volume: 25 Issue: 2, 395 - 416, 08.05.2025

Berk Palandökenlier , Harun Bal

https://doi.org/10.21121/eab.20250210

Abstract

The aim of our study is to investigate the scope and effectiveness of sterilization measures against different types of foreign capital inflows for 13 Emerging Market Economies (EMEs) over the period 2005Q1-2021Q4 and the extent to which such measures differ across countries and periods. In this framework, the question of the extent to which the extent of sterilization measures implemented by the EMEs to offset the macroeconomic effects of domestic monetary expansion resulting from foreign exchange intervention varies across countries and periods is investigated using the Instrumental Variables GMM technique. Moreover, the extent to which the effectiveness of sterilization policy differs across types of capital flows is investigated using quantile regression analysis. The findings of the research, the sterilization coefficients calculated for each EMEs and the panel analysis findings for the whole sample reveal the existence of partial sterilization in general. These results suggest that full sterilization is not implemented to reduce the long-run economic costs and to support domestic economic stability. On the other hand, quantile regression analysis reveals that sterilization measures are particularly effective against short-term private capital inflows. With these measures, it would be possible to limit the effects of different types of capital inflows and make the economy more stable.

Keywords

International private capital flows , Monetary policy , Sterilization coefficient , International reserves

References

• Ahmed, S., Coulibaly, B., & Zlate, A. (2017). International financial spillovers to emerging market economies: How important are economic fundamentals?. Journal of International Money and Finance, 76, 133-152.
• Aizenman, J., & Glick, R. (2009). Sterilization, monetary policy, and global financial integration. Review of International Economics, 17(4), 777-801.
• Aizenman, J., & Lee, J. (2007). International reserves: precautionary versus mercantilist views, theory and evidence. Open Economies Review, 18(2), 191-214.
• Altinkemer, M. (1998). Capital Inflows and Central Bank’s Policy Response. The central bank of the Republic of Turkey, Research Department.
• Arya, V., Cavoli, T., & Onur, I. (2020). Do managed exchange rates and monetary sterilization encourage capital inflows?. Plos one, 15(8), e0238205.
• Baltagi, B. H. (2001). A companion to theoretical econometrics (Vol. 1). B. H. Baltagi (Ed.). Oxford: Blackwell.
• Baum, C. F., Schaffer, M. E., & Stillman, S. (2003). Instrumental variables and GMM: Estimation and testing. The Stata Journal, 3(1), 1-31.
• Beirne, J., Renzhi, N., Sugandi, E., & Volz, U. (2021). COVID‐19, asset markets and capital flows. Pacific Economic Review, 26(4), 498-538.
• Calvo, G. A. (1991). The perils of sterilization. Staff Papers, 38(4), 921-926.
• Calvo, G. A., Izquierdo, A., & Mejia, L. F. (2004). On the empirics of sudden stops: the relevance of balance-sheet effects (No. w10520). National Bureau of Economic Research.)
• Cardarelli, R., Elekdag, S., & Kose, M. A. (2010). Capital inflows: Macroeconomic implications and policy responses. Economic Systems, 34(4), 333-356.
• Cavoli, T. (2007). Sterilization, capital mobility and interest rate determination for East Asia. Journal of Economic Integration, 210-230.
• Cavoli, T. (2017). Managing capital inflows indirectly? On the determinants of monetary sterilization with reference to East Asia. Review of International Economics, 25(2), 262-278.
• Cavoli, T., & Rajan, R. S. (2006). Capital inflows problem in selected Asian economies in the 1990s revisited: the role of monetary sterilization. Asian Economic Journal, 20(4), 409-423.
• Cheung, Y. W., & Qian, X. (2009). Hoarding of international reserves: Mrs Machlup’s wardrobe and the Joneses. Review of International Economics, 17(4), 824-843.
• Christensen, J. (2004). Capital Inflows, Sterilization, and Commercial Bank Speculation: The Case of the Czech Republic in the Mid-1990s.
• Cook, D. E., & Yetman, J. (2012). Expanding central bank balance sheets in emerging Asia: a compendium of risks and some evidence. BIS Paper, (66d).
• Darvas, Z. (2024). Real effective exchange rates for 178 countries: a new database.
• Das, M., Gopinath, G., & Kalemli-Özcan, Ş. (2022). Preemptive policies and risk-off shocks in emerging markets (No. w29615). National Bureau of Economic Research.
• Eguren Martin, F., Joy, M., Maurini, C., Nispi Landi, V., Schiavone, A., van Hombeeck, C., & Moro, A. (2020). Capital flows during the pandemic: lessons for a more resilient international financial architecture. Bank of Italy Occasional Paper, (589).
• Emir, O. Y., Karasoy, A., & Kunter, K. (2000). Monetary policy reaction function in Turkey. Discussion Papers, 5. European Central Bank. (2006). The Accumulation of Foreign Reserves, by an International Relations Committee Task Force. ECB.
• Fair, R. C. (1970). The estimation of simultaneous equation models with lagged endogenous variables and first order serially correlated errors. Econometrica: Journal of the Econometric Society, 507-516.
• Filardo, A., George, J., Loretan, M., Ma, G., Munro, A., Shim, I., ... & Zhu, H. (2010). The international financial crisis: timeline, impact and policy responses in Asia and the Pacific. BIS papers, 52.
• Frankel, J. A., & Okongwu, C. (1996). Liberalized Portfolio Capital Inflows in Emerging Markets: Sterilization, Expectations, and the Incompleteness of Interest Rate Convergence. International Journal of Finance & Economics, 1(1), 1–23. doi:10.1002/(sici)1099- 1158(199601)1:1<1::aid-ijfe1>3.0.co;2-k.
• Grilli, V., & Milesi-Ferretti, G. M. (1995). Economic effects and structural determinants of capital controls. Staff Papers, 42(3), 517-551.
• Gupta, A. S., & Sengupta, R. (2014). Capital Flows and Capital Account Management in Selected Asian Economies. Mpra Paper, 58982, 12-30.
• Hassan, M. K., Nakibullah, A., & Hassan, A. (2013). Sterilisation and monetary control by the GCC member countries. The World Economy, 36(12), 1566- 1587.
• Hördahl, P., & Shim, I. (2020). EME bond portfolio flows and long-term interest rates during the Covid-19 pandemic. BIS Bulletin, (18).
• International Monetary Fund (IMF). Research Department. (2009). World Economic Outlook, April 2009: Crisis and Recovery. International Monetary Fund.
• Khemraj, T., & Pasha, S. (2012). Dual nominal anchors in the Caribbean. Journal of Economic Studies, 39(4), 420-439.
• Kim, G. (1995). Exchange rate constraints and money control in Korea. Research and Public Information Division, Federal Reserve Bank of St. Louis.
• Kouri, P. J., & Porter, M. G. (1974). International capital flows and portfolio equilibrium. Journal of political Economy, 82(3), 443-467.
• Kwack, S. Y. (2001). An empirical assessment of monetary policy responses to capital inflows in Asia before the financial crisis. International Economic Journal, 15(1), 95-113.
• Leybourne, S., & Newbold, P. (1999). On the Size Properties of Phillips-Perron Tests. Journal of Time Series Analysis, 20(1), 51–61.
• Ljubaj, I., Martinis, A., & Mrkalj, M. (2010). Capital Inflows and Efficiency of Sterilisation–Estimation of Sterilisation and Offset Coefficients (No. 24).
• Mahraddika, W. (2019). Does international reserve accumulation crowd out domestic private investment?. International Economics, 158, 39-50.
• Mansour, L. (2012). Hoarding of International Reserves and Sterilization in Dollarized and Indebted Countries: an effective monetary policy?.
• Mendoza, R. U. (2010). Was the Asian crisis a wake-up call?: Foreign reserves as self-protection. Journal of Asian Economics, 21(1), 1-19. Meng, Z., Wei, W., Liu, X., & Yin, K. (2018). The Influence of International Capital Flow on the Effectiveness of Chinese Monetary Policy. Romanian Journal of Economic Forecasting, 21(4), 21-40.
• Montiel, P. (1998). The capital inflow problem. Economic Development Institute, World Bank.
• Montiel, P. J. (1999, April). Policy responses to volatile capital flows. In lavoro presentato alla conferenza organizzata da World Bank/IMF/WTO su” Capital Flows, Financial Crises, and Policies (pp. 15-16).
• Moreno, R. (1996). Intervention, sterilization, and monetary control in Korea and Taiwan. Economic Review-Federal Reserve Bank of San Francisco, (3), 23.
• Nakibullah, A. (2011). Monetary policy and performance of the oil-exporting Gulf Cooperation Councial countries. International Journal of Business and Economics, 10(2), 139-157.
• Nwogwugwu, U. C. C., Ibikunle, J. A., Uzoechina, B. I., Anthony, C. O., & Anyachebelu, U. M. (2020). Investigating the effectiveness of sterilization policy in controlling money supply and capital inflows in Nigeria. Acta Economica, 18(32), 127-150.
• Obstfeld, M. (1982). Can we sterilize? Theory and evidence (No. w0833). National Bureau of Economic Research.
• Ouyang, A. Y., & Rajan, R. S. (2011). Reserve accumulation and monetary sterilization in Singapore and Taiwan. Applied Economics, 43(16), 2015-2031.
• Ouyang, A. Y., Rajan, R. S., & Willett, T. (2008). Managing the monetary consequences of reserve accumulation in emerging Asia. Global Economic Review, 37(2), 171- 199.
• Ouyang, A. Y., Rajan, R. S., & Willett, T. D. (2010). China as a reserve sink: The evidence from offset and sterilization coefficients. Journal of International Money and Finance, 29(5), 951-972.
• Park, D., & Estrada, G. B. (2009). Are developing Asia’s foreign exchange reserves excessive? An empirical examination. An Empirical Examination (August 1, 2009). Asian Development Bank Economics Working Paper Series, (170).
• Pesaran, M. H. (2004). General diagnostic tests for cross section dependence in panels. Available at SSRN 572504. Pesaran, M. H. (2007). A simple panel unit root test in the presence of cross‐section dependence. Journal of applied econometrics, 22(2), 265-312.
• Pesaran, M. H., & Yamagata, T. (2008). Testing slope homogeneity in large panels. Journal of econometrics, 142(1), 50-93.
• Pesaran, M. H., Ullah, A., & Yamagata, T. (2008). A bias‐adjusted LM test of error cross‐section independence. The econometrics journal, 11(1), 105- 127.
• Pesaran, M.H., 2004. “‘General Diagnostic Tests for Cross Section Dependence in Panels’,” Cambridge Working Papers in Economics 0435, Faculty of Economics, University of Cambridge.
• Reinhart, C. M., & Reinhart, V. (1998). Some lessons for policy makers who deal with the mixed blessing of capital inflows. Capital flows and financial crises, 93- 127.
• Reinhart, C., & Dunnaway, S. (1996). Dealing with capital inflows: Are there any lessons? MPRA Paper 13764, University Library of Munich, Germany.
• Roubini, N. (1988). Offset and sterilization under fixed exchange rates with an optimizing central bank.
• Siklos, P. L. (2000). Capital flows in a transitional economy and the sterilization dilemma: the Hungarian experience, 1992–97. The Journal of Policy Reform, 3(4), 373-392.
• Söderbom, M. (2009). Applied econometrics lecture 2: Instrumental variables, 2SLS and GMM. Retrieved June, 30, 2014.
• Takagi, S., & Esaka, T. (2001). Sterilization and the capital inflow problem in East Asia, 1987-97. In Regional and global capital flows: Macroeconomic causes and consequences (pp. 197-226). University of Chicago Press. Verbeek, M. (2008). A guide to modern econometrics. John Wiley & Sons.
• Wang, Y. (2010). Effectiveness of capital controls and sterilizations in China. China & World Economy, 18(3), 106-124.
• Wang, Y., Li, X., Huang, D., & Wang, A. (2021). Revision of the Effectiveness of China’s Sterilization Policies Considering the Role of the Reserve Requirement Ratio Adjustment. Emerging Markets Finance and Trade, 57(5), 1420-1436.
• Wang, Y., Willett, T. D., & Li, X. (2019). International capital flows and the independence of China’s monetary policy. The Chinese Economy, 52(4), 300-317.
• Zhang, C. (2010). Sterilization in China: effectiveness and cost. Available at SSRN 1708162.