Empirical Analysis Of China Foreign Exchange Reserves' Optimum Scale

With the rapid economic growth and deeply development of foreign economic contact, especially after China enter WTO, China's foreign exchange reserves (CFER) has soared quickly. In 2005, the balance of international payments had realized favorable balance to 223.782 billion in both current account and capital account. This situation is continued, and the amount had reached to 259.9 billion in 2006. However, the expanding favorable balance of international payments had resulted to the rapid growth of CFER. In 2006, CFER topped 1000 billion dollars to reach 1066.3 billion dollars. Such huge amount of CFER, on the one hand means continuous improvement of China's overall national strength; on the other hand , it induces trade frictions and the pressure on the appreciation of the Renminbi. Furthermore, owing to the excessively rapid CFER growth, Central Bank of China was forced to put more basic money into circulation which causes plenty of funds outstanding for foreign exchange, distorts the putting way of basic money, reduces independence of monetary policy, results the excessive liquidity of money and hits the price. Thus, it is of great theoretical and practical significance to study the formation, moderate scale and management of CFER.In this paper, to integrate the demand for reserves theory and the monetary approach, firstly, a long-run money demand function for China is estimated by VEC model using quarterly data over the period 1992-2006 to measure the extent of monetary disequilibrium, and then monetary disequilibrium is incorporated as an additional variable influencing CFER, constructing the demand function of CFER to estimate moderate scale of CFER. It is found that there is long stable relationship between demands of CFER and import scale, fluctuating rate of balance of international payments and average propensity to import. The moderate scale of CFER is 492.7 billion at the end of 2006, and now the CFER is excessive in scope. In this paper, it is proposed that current situation of CFER could be relieved effectively through reform of the rate management system, adoption effective CFER investment strategy.