Foreign Exchange Intervention In China:Motives And Strategies

Post crisis period,the imbalance of economic fundamentals makes the global financial markets appear differentiation,cross-border capital flows raise a challenge to monetary policy and financial stability.In view of the lessons of the financial crisis,foreign exchange intervention has been widely adopted by countries all over the world as an important policy tool.For a long time,the purpose of China’s central bank foreign exchange intervention is to maintain the basic stability of the RMB exchange rate at a reasonable and balanced level.However,due to the increasing cost of intervention policy in the process of deepening reform and opening up,it is no longer suitable for the gradual opening of the market environment.Currently,China’s central bank foreign exchange intervention is controversial,some scholars think foreign exchange intervention distorts equilibrium price,advocating the expansion of the exchange rate flexibility and reducing foreign exchange intervention;other scholars think RMB has achieved long-term equilibrium,foreign exchange intervention should be reserved to stable exchange rate expectations and avoid overshoot risk.Re examination of China’s foreign exchange intervention is not to deny the necessity of intervention,but to improve the existing improper intervention behavior.With the continuous improvement of China’s exchange rate and interest rate liberalization as well as the gradual opening of RMB capital account,reasonable and effective foreign exchange intervention has become an important demand to prevent financial risks.Deep analysis of central bank foreign exchange intervention interval,methods,and the coordination of goals,has important significance to both the gradual and orderly opening up of the capital account,and the central bank taking appropriate policy measures to relieve the asset price volatility impact on financial markets and the real economy.This paper firstly summarizes the foreign exchange intervention experience of major economies.Then analyzes the RMB exchange rate dynamics and the practice of foreign exchange intervention,calculating RMB equilibrium exchange rate and misalignment degree,the foreign exchange market pressure index,and the foreign exchange intervention index,establishing econometric models to demonstrate the necessity and effectiveness of China’s foreign exchange intervention,interpreting the problems of current China’s foreign exchange market intervention.Finally put forward China’s foreign exchange intervention optimization strategy under open conditions,and provide the beneficial reference for the smooth operation of China’s macro-economy.The main conclusions are as follows:first,from the perspective of international experience,the reasonable foreign exchange market intervention has the function of safeguarding the economic security.Central bank’s positive foreign exchange intervention has a wave mitigation role to both nominal and real effective exchange rate,achieving the effect of stabilization,besides,the greater the volatility of capital markets,the greater the trade imbalance,the greater the spread,the higher the inflation,usually associated with the more unstable the exchange rate.Second,from the point of view of the RMB exchange rate dynamics,if the current exchange rate is disordered,it would take a long time back to equilibrium level,costing far more than that of intervention,thus foreign exchange intervention is needed to make it return smoothly;if exchange rate is in the state of equilibrium,intervention is also needed to reduce the overshoot risk,therefore,foreign exchange intervention is necessary.Third,from the perspective of China’s foreign exchange intervention practice,it is not sustained and always effective.Non-effective foreign exchange intervention will not only increase the exchange rate price distortions,and also weaken the independence of monetary policy,expanding the impact of speculative capital risk and accelerating the loss of foreign exchange reserves,improve the improper intervention is imperative.Fourth,to realize the reasonable intervention,China’s central bank need to have the appropriate timing of intervention,flexible interventions coordinated with the goal of intervention,supporting macroeconomic policies and gradually improved market environment.During the intervention,different intervention methods exert different impact on the degree of exchange rate fluctuations.Ruled-based intervention is more moderate and steady,as well as a smaller cost than discretional intervention.In response to the attack,rule-based intervention also has a strong stabilizing role.The innovation of this paper lies in:on the research methods,studies the effect of intervention on the exchange rate relying on an instrumental-variables panel approach;constructs the TVP-VAR model to verify RMB nominal exchange rate overshooting caused by short-term impact;estimates China’s foreign exchange intervention index,and establishes the DCC-GARCH model to test the correlation between intervention index and the real effective exchange rate;under the partial equilibrium model of three departments,builds the target range of exchange rate intervention;expands the new Keynes dynamic stochastic general equilibrium model,adding the foreign exchange intervention,capital controls,and the transition of monetary policy into the model framework,introducing risk averse traders,revising UIP expression with the endogenous risk premium and capital control,analyzing the response of macro-economy under different impact types and different scenes of intervention in order to assess the effect.In the framework of research,puts forward China’s foreign exchange intervention optimization strategy under the open conditions,elaborates the content of the strategy from three dimensions:intervention timing,intervention method and intervention objective coordination,in order to improve the policy framework for intervention in the foreign exchange,and provide theoretical support for the operation of foreign exchange intervention.