The sterilized asset purchase program is a new policy tool for dealing with sudden stops.
The central bankers of emerging and developing economies (EMDEs) have sought other policy tools than traditional interest rate policy. These economies risk financial disruptions from sharp reversals of capital inflows. This is a sudden stop when foreign investors suddenly withdraw their funds. However, the theory behind unconventional monetary policies still needs to be fully supported. Recent literature, including IMF’s Integrated Policy Framework, has begun to offer frameworks for exploring these tools.
Similar to this literature, my job paper proposes a theoretical framework for sterilized asset purchase programs. These are unorthodox monetary policies that EMDEs implemented for the first time during the recent COVID-19 crisis (IMF 2020; World Bank 202). The specifics of these programs differ from country to country. Figure 1 shows how many assets were purchased by 14 EMDEs between March and August 2020. It is interesting to note that asset purchases were often sterilized to prevent inflationary pressures. This contrasts with the policy of quantitative easing in advanced countries. Central banks used various methods to fix asset purchases instead of creating monetary bases (for example, bank reserve). In Poland, for example, central bank securities were issued, and in Croatia, foreign exchange (FX) reserves were sold (Arena et al. 2021).
Figure 1: Asset purchases made by countries
Note: The vertical axis shows asset purchases in the percentage of 2020 GDP. The following countries calculate it: Croatia (HRV), Chile (CHL), Colombia [THA], Thailand (THA], Hungary (THA], Philippines (PHP), Indonesia (“IDN”), India (IND), Malaysia (“MYS”), Romania (ROU), South Africa “ZAF”) Turkiye (TUR) and Ghana (GHN). Blue bars represent government bond purchases in both the primary and secondary markets. Orange bars represent private sectors asset purchases, such as corporate bonds and asset-backed securities.
This observation led me to address two questions in my paper. (i) Is a sterilized program for asset purchase a useful policy tool in sudden stoppages? (iii) How do you design this tool? Which asset should be purchased, and how to sterilize it?
I created a small open-economy model to test the effectiveness of sterilized asset purchasing programs. The model economy includes households, banks, nonfinancial businesses, and the consolidated state. To illustrate the facts about EMDEs, (i) liability dollarsization, (ii] financial markets imperfection and (iii] fear losing reserves are some of the conditions. Banks borrow foreign currency from foreign investors and households. The banks then lend domestic currency to nonfinancial businesses. The leverage constraint also applies to banks, making it a binding condition for sudden stops. The government buys corporate bonds and then sterilizes these purchases with FX reserves. But the use of reserves is limited due to the fear-of-losing-reserves constraint.
Figure 2: Funds flowing
Figure 2 shows the flow of funds within the model economy. Normal times banks are the centre of funding flows. They intermediate the supply and demand of funds from households and foreign investors. In turn, the government accumulates FX reserves on the international financial markets. The government is able to fund intermediation when there are sudden stops. To ease financial market disruptions, the government runs sterilized asset purchasing programs. This provides liquidity for the firms and eases the banks’ leverage restrictions.
Implications for policy
My paper has valuable policy implications for EMDs. Sterilized asset purchase programs reduce the impact of sudden stops and improve welfare Corporate bonds that are sterilized using FX reserves will be most effective. Recognize policy trade-offs. The recovery may be slowed by large-scale asset purchases. Finally, stockpiling FX reserves can help improve policy space to prevent sudden stops.
