Sterilization and Inflation in the Long-Term Empirical Evidence from Egypt

Abstract

Although many central banks actively sterilized intervention, there is still no consensus on sterilized effect on the inflation in the long - term. This study aims at answering the question of whether or not sterilized intervention by the central bank of Egypt causes inflation in the long term. In this paper we use annual data from 1980 to 2011and use Granger Causality test, Error Correction model (VECM) and Variance Decomposition. The causal relationship between sterilization and inflation rustles indicate that, there is a bi-directional causality in two and three lags and inflation cause sterilization in four and five lags, that any intervention by the central bank sterilization in Egypt is causing inflation in the period 1980-2011. The VECM results clearly indicate the existence of a long run positive relationship between sterilization and inflation, where sterilization value increased by 10% the change in inflation will be 22% in long – term, but in the short term, all the independent variables were not significant except for the impact of inflation on the same, it is positive and significant. This means that the results of the intervention of the Central Bank of Egypt through the sterilization policy does not limit the inflation in the short term but lead to increased rates of inflation in the long term through the influence in the fiscal deficit, as the sterilization value increased by 10% the change in budget deficit will be 4.4%. The variance decomposition rustles indicates that the relative importance (contrast ratio prediction error interpreter) for a shock occur in sterilization in the interpretation of the change in inflation is positive, continuing and growing, this importance was 1.56% in the second year of shock and then 5.49% in the third year of the shock and then 10.94% in the fourth year and so that up to 45.42% in the tenth year of the shock. This indicates that there is a positive, growing and continuing relationship between sterilization and inflation in Egypt in the period of study.