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Research on the Influence of China’s Foreign Exchange Reserves Growth on Price

Author: ZhangQin
Tutor: GaoYunFeng
School: Southwestern University
Course: Finance
Keywords: Foreign exchange reserves Inflation Foreign exchange write-off
CLC: F832.6
Type: Master's thesis
Year: 2012
Downloads: 281
Quote: 1
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Abstract


With the growth of China economic,there has been consecutive double surplus in balance of international payments in China, which resulted in more foreign exchange reserve. In February 2006, China’s foreign exchange reserves had surpassed Japan and became the world’s largest holder of foreign exchange reserves. The increase of foreign exchange reserves will promote the supply greater than the demand in the foreign exchange market. In order to maintain the exchange rate stable, the central bank will invest a lot of domestic currency to buy the foreign exchange. As a result, a large number of foreign exchange reserve was generated. Foreign exchange generation will cause the central bank input more base money passively. If the central bank doesn’t take any write-off measures, that will lead to the increase of total currency, and ultimately cause the price increases. Since we implement the managed floating exchange rate system,the central bank carries out the corresponding intervening measure to aim at the overmuch foreign exchange. By reviewing the write-off measures to foreign exchange previous years taken by the Central Bank of China, the paper will analyze the effectiveness and also find out the limitations of operations taken by central bank. We find that the write-off measures cannot fully hedged the excess liquidity caused by foreign exchange. Certainly it works in the short term.but it’s not so effective in the long term, further more, it will have a negative effect on the economy. On the other hand, China’s price level has demonstrated a fluctuating trend since reform and opening-up. Especially in recent years, the price has appeared the inflation pressure. The price fluctuation not only affects people’s daily life, but also spreads to various aspects of enterprises and the social economies, thus it affects the stable development of economy in China. The price stability is more than just hot topic, it has become an important goal of the national macro-control.Under the circumstance of soaring foreign exchange reserves, it needs to be noticed that whether the price fluctuations has something to do with foreign exchange reserves increase,and what the relationship between them, or how important the relationship is. Therefore, to aim at the relationship between the increase of foreign exchange reserves and the fluctuation of price level, this paper uses the method of theoretical and empirical analysis, utilizes the basis of monetary theory, the theory of inflation and foreign exchange write-off theory, and selects quarterly data from 2001 to 2010, it eventually comes to the conclusion by entire analysis, empirical analysis of the error correction model and impulse response function. In the short term, the relationship between foreign exchange reserves and price fluctuation is not noticeable. It is due to the foreign exchange write-off measures. The central bank will take some corresponding write-off measures to reduce the passive increase of money supply which is caused by the foreign exchange reserves. In addition, because of the uncompleted financial system’s reform and the imperfect capital market, the feedback channels are blocked which including the relationships between foreign exchange reserves, money supply, price fluctuation and interest fluctuation. Meanwhile, the changes in money supply don’t necessarily arouse the changes in interest rates, because our interest rates reform is not market-oriented and capital projects are not fully open. Thus the transmission mechanism between interest rates and capital projects are blocked. In addition, China’s exchange rate fluctuations weakened the impact on inflation to some extent. In the long term, the central bank couldn’t completely hedge the increased base currency which is caused by the increase foreign exchange reserves due to its limitation of operating space and the negative affects of hedging tools. Therefore, as the invalid foreign exchange write-off measures, the fluctuation of the price level will have corresponding changes because of the increased foreign exchange reserves.Finally, this paper promotes some corresponding policy and suggestion to direct at the large amount of foreign exchange reserves and also the implementation of write-off measures. Firstly, to deepen the reform of foreign exchange management system, which includes completing the system of exchanging, settlement and sales, relaxing the foreign exchange account management, building the flexible exchange rate mechanism and gradually relaxing the scope of exchange rate fluctuations. Secondly, to adopt comprehensive measures in order to balance the international payments, which includes the promotion of high-tech equipments importing, changing the types of export and import commodity, emphasizing attracting more foreign investment, and also guiding the enterprises to combine both "introducing" and "stepping out". Furthermore, to prevent large amount of hot money turnover and improve the foreign exchange management policies, to make scientific and rational use of foreign exchange reserves,to promote positive effectiveness of the foreign exchange reserves on economy. Thirdly, to complete the foreign exchange write-off measures, which include promoting the interest rate fully market-oriented, in order to guarantee the fluent transmitting of monetary policy;innovating the financial tools, enriching the diversification of write-off means, strengthening the construction of open markets and also strengthening the coordination and use of monetary policy and fiscal policy.

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CLC: > Economic > Fiscal, monetary > Finance, banking > China's financial,banking > Exchange rate,foreign financial relations
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