Formation And Its Inflationary Effects Of Excess Foreign Exchange Reserves

Because of China’s Compulsory foreign exchange settlement and sale policy, andChina formally joined the WTO (World Trade Organization) in2001.China’sinternational balance of payments have double surplus in current and capital accountfor years, foreign exchange reserves have also started to increase rapidly. From2001to2012, it goes from2121billion dollars to33116billion dollars. At the same time,the economic development of our country has stepped into a new stage, but alongwith the economic development, China’s domestic commodity prices level began torise. China’s CPI (Consumer Price Index) began to rise from2004, and in2008Feb itreached the highest value. To because of this, many domestic scholars began to studyon the relationship between foreign exchange reserves and inflation, people began topay attention to the relationship between excess foreign exchange reserves and theprice level. Based on the previous researches, this paper starting from theory andempirical，to study the relationship between excess foreign exchange reserves andinflation.In theory, a large number of foreign exchange reserves can keep the stability ofChina’s exchange rate, but also can enhance china’s foreign payment ability. On theother hand excess foreign exchange reserves will also bring negative effects to oureconomic that can’t be offset by the internal control. The excessive foreign exchangereserve will bring about an increase in china’s base money, so the base currency tendsto increase, through the money multiplier effect, the money supply will be substantialgrowth, resulting in rising domestic commodity prices, finally bring us inflationarypressures.From the empirical aspect, this paper use co-integration test to analysis therelationship between the growth rate of foreign exchange reserves and CPI, found thatfrom1994-2002, the growth rate of foreign exchange reserves with CPI indeed thereis a long-term stable relationship; Then use granger causality test to test the causalityof excess foreign exchange reserves and CPI, with the conclusion that the excessforeign exchange reserves is the granger reason of domestic inflation, but inflation isnot the excess foreign exchange reserves’ granger reason.