The Research On The Effect Of Foreign Exchange Reserves In China Upon Monetary Policy

China’s foreign exchange reserves began to rise sharply after the foreign exchange systemreformed in1994. As a result, china’s foreign exchange reserves became the largest one in the worldin2006and even breakthrough$3trillion mark in2011. In the end of2012, China’s foreignexchange reserves reached$3.31trillion. We can notably find the downward trend of China’sforeign exchange reserves for the first time in the same year, but this decline will be temporary as itwas mostly caused by the debt crisis in Europe and the American slowly economic recovery andother external factors. The adjustment of China’s export-oriented economic policy after thefinancial crisis in2008as well as the worsening debt crisis in Europe leads to China’s exportsdecline and China’s foreign exchange reserves’ growth slow. Despite China’s recent foreignexchange reserves grow slowly, the total amount of China’s foreign exchange reserves is still huge.The excessive foreign exchange reserves have changed the supply of base money, which enhancethe endogencity of money supply and reduce the effectiveness of monetary policy.This paper analyzes the impact of the foreign exchange reserves on China’s monetary policyfrom both normative and empirical perspective, which is based on the relevant theoretical research.Both empirical and normative analyses have proved that China’s foreign exchange reserve growthcauses the increase of funds outstanding for foreign exchange which forced the money supply toexpand. The enhanced domestic liquidity boost the central bank’s write-off pressure and RMBappreciation pressure, as well as the society’s inflationary pressures. Empirical analysis of thispaper shows, in recent years, foreign exchange reserves is strongly related to the central bank’smonetary policy operation tools, the intermediate target and the ultimate goal. The correlation andthe negative impact verify the growth of foreign exchange reserves negatively influence theindependence and effectiveness of the monetary policy. Finally, on the basis of these analyses, thispaper puts forward corresponding suggestions and measures to mitigate this negative effect.