Question

(TCO C) Answer the following questions regarding direct, sterilized and nonsterilized intervention. a. If most countries in Europe experience a recession, how might the European Central Bank use direct intervention to stimulate economic growth? (10 points) b. What is the difference between sterilized and nonsterilized intervention? (10 points)

Answer 1

Direct intervention can be performed by the European Central Bank by selling Euros in the foreign exchange market. The impact of this intervention will be that the value of Euro will depreciate against other currencies due to the higher supply of euros. This will make euros cheaper and there will be higher demand for European imports. Moreover this will attract foreign investment and help to tackle the recessionary problem in the economy.

Non sterilized intervention occurs when the central bank intervenes in the foreign exchange market by changing the money supply. This may be performed by sale and purchase of the domestic currency.

Sterilized intervention refers to sale and purchase of foreign currency to impact the value of the domestic currency. This may be performed either by dealing in foreign currency assets or with the help of open market operations.