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Foreign exchange intervention and sterilization: an investigation of State Bank of Pakistan’s Reaction Function

Waheed, Muhammad (2010): Foreign exchange intervention and sterilization: an investigation of State Bank of Pakistan’s Reaction Function.

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Abstract

We looked into Pakistan’s central bank response to the foreign exchange inflows, for the period from 2001:01 to 2007:06, to strike a balance between competing goals of internal and external equilibriums to draw lessons for its conduct going forward. Using a reaction function we tested the hypothesis that SBP fully sterilized its foreign exchange interventions. The results indicated that for this period, SBP only partially neutralized its foreign exchange interventions. In addition, we also found that changes in SBP’s domestic credit were counter cyclical as it had negative relation with the output gap. However, the changes in domestic credit were found to have positive relation with changes in inflation. This probably resulted from too much weight assigned to growth objective in the back drop of recession and low inflation environment at the start of 2001. It was also found that the SBP also change its domestic credit systematically to reduce interest rate variability at the short end.

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