Under the regime of managed floating exchange rates, sterilized foreign exchange intervention is ineffective with perfect asset substitutability between domestic assets and foreign assets. However, it may be effective with imperfect asset substitutability. Suppose that the Korean economy is hit by a negative shock such as the decrease in the world demand for Korean products. Explain how sterilized foreign exchange intervention by the Korean government and the Bank of Korea can effectively control the fluctuations in the Won/Dollar exchange rate.

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