This article, originally published in Spanish in La Nación, December 31, 2006, explains the mechanics of the Argentine Central Bank's intervention in exchange rates markets to target a stable and competitive exchange rate, a macroeconomic policy that has played a significant role in Argentina's economic growth since 2002.

Roberto Frenkel

English

Research Papers in Economics

Issue Brief • February 2007  
 
Center for Economic and 
Policy Research 
1611 Connecticut Ave, NW 
Suite 400 
Washington, DC 20009 
202-293-5380 
www.cepr.net 
Argentina: The Central Bank in the 
Foreign Exchange Market 
 
BY ROBERTO FRENKEL 
 
It is the beginning of 2007 and the issue of the Argentine Central Bank’s 
intervention in the exchange rate market continues to be confusing for the public 
and also for many economists.  Articles in the press are not very helpful and there is 
a worrisome lack of technical papers on the subject. Taking advantage of the 
summer break, I will try to entertain the reader with a somewhat technical 
contribution on this issue. 
The Central Bank intervenes in the foreign exchange market by buying foreign 
currency to maintain a certain exchange rate and to accumulate international 
reserves. The first thing to understand is that with these interventions, the Central 
Bank does not lose control over the money supply or the short-term interest rate. 
Certainly, the Central Bank causes an expansion of the monetary base when it buys 
dollars – which would induce a decline in the interest rate.  But it can fully 
compensate for this expansion – and consequently keep the interest rate unchanged 
– by absorbing the increase in liquidity generated by the intervention in the foreign 
currency market. This is called a fully sterilized intervention.  
The Central Bank and the Treasury of Argentina have been absorbing the expansion 
generated in the exchange market through various means.  However, to take the 
extreme version of the argument, let’s assume that all absorption is carried out by 
the Central Bank through the issuance of securities—our Lebacs (bills) and Nobacs 
(notes) in Argentina. 
The excess supply of foreign currency in the market – at the exchange rate that the 
Central Bank wants to maintain and at the current domestic interest rate – is 
equivalent to an excess demand of assets denominated in Argentine pesos. We can 
imagine a fully sterilized intervention as an operation in two steps. In the first step, 
the Central Bank buys the excess supply of dollars and expands the monetary base.  
The result would be an increased money base, an unchanged quantity of interest-
bearing domestic financial assets, and a lower domestic interest rate than the initial 
one. 
 
Roberto Frenkel is a senior research associate at the Center for Economic and Policy Research in Washington, DC. 
 
Translated from the original Spanish, which was published in La Nación December 31, 2006.The Central Bank in the Foreign Exchange Market • 2  
 
In the second step, the Central Bank sells financial assets by exactly the same amount as the initial 
excess in demand – thus increasing the quantity of domestic assets by that amount – and absorbs the 
increase in the monetary base, causing the interest rate to return to its original level. 
Through these operations the Central Bank compensates for the change in the private sector’s 
portfolio. The private sector wanted more domestic assets, and in exchange offered assets in foreign 
currency. In the absence of an intervention by the Central Bank, prices would have to adjust.  But 
instead, the Central Bank supplies the domestic assets being demanded and ends up with more 
foreign assets, leaving prices (the exchange rate and the interest rate) unchanged.     
A fully sterilized intervention through the purchase of foreign currency is possible at any moment in 
time. But is it possible to do this indefinitely? Not always. It depends on the interest rate on foreign 
reserves, the domestic interest rate and the change in the exchange rate. If the domestic interest rate 
is too high relative to the sum of the international interest rate and the growth rate of the exchange 
rate, the Central Bank can face increasing sterilization costs and lose control of the monetary 
variables. This is not the case in Argentina: due to reasonable domestic interest rates, the 
sustainability of a sterilization policy is not an issue. 
To further illustrate the argument, let’s consider some figures for the Argentine economy.  To 
simplify matters, we will use approximate values for the main components of the Central Bank’s 
balance sheet. 
First, let’s take a look at the actual cost of sterilization. The Central Bank’s liabilities (bills and notes) 
amount to 40 billion Argentine pesos (ARS), which pay approximately 10 percent in interest. 
Consequently, the financial cost per year of these liabilities represent about ARS 4 billion. On the 
other side of the balance sheet, international reserves amount to some USD 31 billion (around ARS 
96 billion). The return (in pesos) on these reserves is approximately 7 percent. This return is 
composed of the international interest rate obtained on the reserves (4 percent) plus an annual 3 
percent for the growth rate of the nominal exchange rate.  Thus, the reserves yield an annual return 
of ARS 6.7 billion. As can be seen, ARS 6.7 billion is more than ARS 4 billion. Income generated by 
the reserves is higher than the financial cost of the sterilization securities. 
But if the relevant domestic interest rate (10 percent) is higher than the sum of the international 
interest rate and the growth rate of the exchange rate (7 percent), why does income turn out to be 
higher than costs? Logically, it is because the Central Bank’s sterilization liabilities are less than the 
reserve assets. One reason for this difference is that the Central Bank can (and must) also issue 
another type of liability, the demand increase for the monetary base, which does not bear interest 
but which is also demanded.  This issuing of base money is called seigniorage and is subtracted from 
the sterilization needs. Currently, the existing monetary base represents some ARS 70 billion. If the 
demand for monetary base grows at the same pace as nominal GDP (unit elasticity), a 20 percent 
increase in nominal GDP – more or less like the one we had in 2006 – represents an increase in the 
demand for base money of ARS 14 billion. 
Taking into account the previous considerations, we are now able to sketch out the results of a full 
sterilization in 2007, assuming that the Central Bank buys USD 10 billion during the year. We also 
assume a nominal GDP growth of 17 percent (less than in 2006). The purchase of dollars mentioned 
above would mean an expansion of the monetary base of approximately ARS 31 billion. The interest The Central Bank in the Foreign Exchange Market • 3  
payments on the existing sterilization securities (10 percent of ARS 40 billion) represent an 
additional ARS 4 billion in base expansion. In order to calculate the sterilization requirements, to 
those ARS 35 billion in base expansion, one must subtract ARS 12 billion that correspond to the 
increase in monetary base (with a unit elasticity of GDP, this is the 17 percent of the current base 
stock of ARS 70 billion). The result is a need for sterilization of ARS 23 billion. At the end of 2007, 
the sterilization liabilities would reach ARS 63 billion and international reserves would be 
approximately USD 42 billion. 
Note that at the end of 2006, the ratio of monetary plus sterilization liabilities to international 
reserves was 1.15 (ARS 110 billion in liabilities / ARS 96 billion in reserves). Assuming a 3 percent 
increase in the exchange rate and a 4 percent return on foreign investments, this ratio would be 1.08 
by the end of 2007 (ARS 145 billion in liabilities / ARS 134 billion in reserves). Could anyone please 
tell me where the problem is? 
FIGURE 1 
Argentina: International Reserves, Monetary Base, and Lebacs and Nobacs  
 
 
Source: Central Bank of Argentina (Banco Central de la República Argentina) 
 
 

Argentina: The Central Bank in the Foreign Exchange Market

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Argentina: The Central Bank in the Foreign Exchange Market

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