Sterilization is a central bank's effort to neutralize the effects of foreign exchange operations on a nation's currency value. If capital inflows to a country faster than it outflows, the currency can appreciate, which would lead to the loss of competitiveness, and inflation might become a problem. In this case, the central bank may need to intervene in the economy to counteract these changes and preserve macroeconomic stability. The bank does this by selling bonds and sucking up some of that surplus capital in circulation, essentially stockpiling reserves. This hoarding removes upward pressure on the currency by reducing the money supply, thereby lowering demand for goods, and is often a measure used to protect export industries. It is a particularly pertinent and controversial issue in today's global economy because China is doing it at the moment en masse, pegging the yuan at a low value to protect their exports and fully capitalize on their comparative advantage in labor. This is particularly controversial in the US because it means much of the United States export industry, especially manufacturing, is fairly disadvantaged and also because American consumers have continued to splurge on cheap Chinese goods, which louses up the US balance of payments. China has bought up billions of US dollars through intervention, often coupled with sterilization. China accounts for the increased demand for Chinese goods due to the low exchange rate by selling its currency in exchange for dollars so that Americans can buy the Chinese goods. Stabilized intervention helps shore up the imbalance of payments, and maintains a stable exchange rate as well as domestic prices and incomes. Some economists fear this could also act as a financial weapon of mass destruction should China ever decide to flood the market with all those dollars, akin to dropping a nuclear bomb of inflation on the US.
Sources: Grieco, Joseph M., and G. John Ikenberry. State Power and World Markets: The International Political Economy. New York: W.W. Norton & Co., 2003.