Effectiveness And Cost Of China’s Monetary Sterilization

China’s international balance of payments surplus have been increasingrapidly Since1999. in order to maintain a relatively stable exchange ratepolicy, our central bank Sells yuan and buys foreign currency in the foreignexchange market, which leads to a sharp rise of China’s foreign exchangereserves.Due to the Linkage relationship between the growth of China’s foreignexchange reserves and base money, base money and domestic moneysupply take a rapid growth during this period. Once the domestic moneysupply Exceed the country’s demand for money, it will increase domesticinflationary pressure and threaten the independence of domestic monetarypolicy. In Theory, sterilization can help an economy,without full capitalmobility,to achieve some extent independence of its foreign exchangepolicy.This article focuses on the following questions: Firstly, whether thesterilization tools of China are effective; Secondly, whether the intensityof sterilization changes structurally; Thirdly, cost and sustainability ofsterilization.This paper discusses two main monetary sterilization method of thecentral bank-issuing central bank bills and adjusting reserve rate. Chapter III introduces the effectiveness of the entral bank bills from the two aspectsof the transmission mechanism and empirical test analysis. In BGT modeltheoretical framework, it established a set of simultaneousequations,including capital flow equation and monetary policy equation. Inorder to examine whether structural changes of central bank bills issuingoccurred in the last decade, it introduces two time dummies. The resultsshows that before the second quarter of2002, the central bank did notoffset capital inflows; from the third quarter of2002to the second quarterof2010, with the rapid growth of foreign exchange reserves and domesticinflation pressure, sterilization intensity is very large, and even beexcessive; after the third quarter of2010, central bank bills sterilizationsignificantly decline, partially because of reduced capital inflows after theU.S. subprime mortgage crisis and reserve ratio policy sterilization is moreused.Chapter IV studies the effectiveness of reserve ratio policy from bothTransmission mechanism and empirical test. Reserve policy is an indirectsterilization pool. It is impossible to measure the sterilization coefficientspecifically, but can come to the validity conclusions. In this paper,cointegration test and Granger causality test are used to verify the reversechanges between the commercial bank deposit reserve and money supply,and the variance decomposition are used to test the influence of reservescale on commercial bank credit. Generally speaking, the policy of adjusting the reserve ratio to shrink the size of credit is relatively effective.The last of paper is about sterilization cost, including systematicanalysis of the impact on the economic system and distortions on financialmarkets. Suggestions on how to alleviate the pressure on foreign exchangesterilization, including the relaxation of the exchange rate band, reformingmandatory foreign exchange settlement system, encouraging foreigninvestment are proposed. It also suggests to establish the ExchangeStabilization Fund to cut off the ties between the foreign exchange reservegrowth and base money.