Staff Report 116

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On the Denomination of Government Debt: A Critique of the Portfolio Balance Approach

David K. Backus
Patrick J. Kehoe

Published November 1, 1988

We show that some classes of sterilized interventions have no effect on equilibrium prices and quantities. The proof does not require complete markets, Ricardian equivalence, monetary neutrality, or the law of one price. Moreover, regressions of exchange rates or interest differentials on variables measuring debt’s currency composition contain no information about the effectiveness of such interventions. Other interventions require changes in monetary and fiscal policy; their effects depend, generally, on the influence of these changes on the economy and not on the intervention alone. In short, sterilized intervention is not, as the portfolio balance approach indicates, an extra policy instrument.

Published In: Journal of Monetary Economics (Vol. 23, No. 3, May 1989, pp. 359-376)

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