Core Focus: The distinction between sterilised and unsterilised intervention, their operational mechanics, implications for monetary policy implementation, and the debate over effectiveness.

In-Depth Notes:
A critical distinction in FX intervention is whether the central bank sterilises the impact on the domestic money supply. A sterilised intervention involves offsetting the monetary impact through open market operations; an unsterilised intervention does not, allowing the transaction to change the money supply .

Unsterilised Intervention:
When a central bank purchases its own currency on the FX market and allows this transaction to change its money supply, it conducts an unsterilised intervention. The key mechanism is that the central bank reduces the relative supply of its currency, strengthening its value in world markets . However, decreasing the money supply can have real economic impacts that the affected countries may be unwilling to experience .

Sterilised Intervention:
To neutralise the effect on domestic money supplies, the central bank engages in open market operations to offset the FX transaction. For example, after buying its currency (reducing its supply), the central bank purchases domestic bonds to put the money back into circulation . The domestic money supply is thus unchanged, and the FX intervention is sterilised .

The Debate on Effectiveness:
The BIS survey shows that most advanced economy central banks sterilise their interventions, including Australia, Japan, Korea, and the UK . However, there has long been a view that sterilised interventions do not work in the long run. According to the fundamentals theory, if an exchange rate is to appreciate, a corresponding slowing of money growth—relative to other countries—is an essential prerequisite . Since sterilised interventions do not change the money supply, they cannot alter the underlying fundamental determinants of exchange rates. Economic research has shown that such interventions are ineffectual, which has dissuaded monetary authorities from engaging in them . Nevertheless, countries continue to engage in sterilised interventions because the alternative—unsterilised intervention—causes other problems, such as disrupting domestic monetary policy .