The long-run effects of central bank intervention on the monetary base: An international perspective

This dissertation seeks to extend current monetary theory by combining the advances in money demand literature with sterilization models. The importance of this research is that it shows and interprets the long-run effects of sterilization of capital flows on the monetary base and money demand.;The Monetary Approach was selected for this thesis because it derives its interpretations from long-run stock variables instead of short-run flow ones. This approach also emphasizes the money market from which balance-of-payments imbalances are derived from. In the determination of the money market equilibrium this dissertation uses modern determinants of money demand in an open economy such as trade weighted exchange rates and world foreign interest rates. When taken as a stock, money demand has been shown to be a stable function of its determinants.;The tests of sterilization and money market cointegration were done using G7 (Germany, France, Italy, The U.K., The U.S., and Japan) data during the current managed float era, 1973:1 to 1992:4. The test for Unit roots was done using the ADF test and the Schwartz information criterion. The results show that all the variables used are first difference stationary. Then, Johansen's multivariate cointegration was used to determine the existence of a long-run stable relationship between the determinants of money demand and the components of the monetary base when exposed to capital flows from flexible exchange rates.;The results reveal that each of the countries contain at least one cointegrating vector indicating that long-run relations exist. Only the U.S. has shown some signs of offsetting between the domestic and foreign components of the monetary base as predicted by monetary theory. This may be because the U.S. dollar is used as a reserve currency weakening the Federal Reserves control over money supply. Japan and the U.K. show signs of complete sterilization thereby canceling out the exchange rate effects on money demand. All the other countries have a positive relationship between the foreign and domestic components of the monetary base this may suggest that these countries use sterilization as an additional policy tool.