Contrary to conventional wisdom, sterilized FX purchases under inflation targeting, i.e., those

that keep the interest rate at the level targeted by the central bank, generally increase

aggregate demand. We develop a simple model with a credit channel to argue that FX

purchases, by funding bank credit, end up increasing aggregate and money demand, while

expanding loans and deposits, and reducing the loan interest rate. Therefore, restoring the

interest rate to the level prior to the FX purchase is not sufficient to prevent an expansionary

effect; the new money market equilibrium, at the same interest rate, will entail a larger money

supply, higher output and greater money demand. Recent Brazilian evidence is reviewed,

showing that this effect may be empirically relevant. If this is the case, inflation targeters may

have another reason to be concerned when conducting FX sterilized interventions, besides

their high cost and controversial effectiveness in preventing nominal appreciation. Even if FX

sterilized purchases are effective in preventing nominal appreciation, they generally boost

activity and inflation, thereby appreciating the real exchange rate.