Studies On Effectiveness Of Sterilized Foreign Exchange Intervention In China

Since the Bretton Wood System collapsed, floating exchange rate regime appeared and foreign exchange rate fluctuated frequently, and the foreign exchange intervention became an important economic policy tool in most countries to maintain the stability or influence the trend of the exchange rate. Foreign exchange intervention will change the balance sheet of the central bank and domestic base money. In order to maintain the independence of domestic monetary policy, a central bank needs to take some sterilization measures to eliminate or weaken the impact of the foreign exchange intervention on domestic base money or money supply. There are many theoretical and empirical study on the effectiveness of sterilized foreign exchange intervention in economic circles. If the sterilized intervention is effective, it means that a central bank could manage the exchange rate while not at the cost of independent domestic monetary policy, and this is of significance in both theory and practice.For China, because of the continuing current account surpluses and capital inflows, China’s foreign exchange reserves continued to grow since2000. China is facing tremendous pressure of the appreciation of RMB. In order to keep the RMB exchange rate stable, the People’s Bank of China has been buying excess supply of foreign exchange to prevent excessive appreciation of the RMB exchange rate. In the process of foreign exchange market intervention, the central bank injected a large amount of high-power base money, resulting in the excessive liquidity in China’s domestic money market and the increasing inflationary pressures. Facing the excessive liquidity and inflationary pressures caused by reserve accumulation, the People’s Bank of China has carried out an active sterilization policy in order to achieve monetary policy target, including issuing interest-bearing central bank bills and raising the required reserve ratio many times.In order to find out how effective the PBOC’s sterilized exchange rate intervention is, this thesis builds a VAR model that contains six variables (net domestic assets, position for Forex purchase, spot exchange rate of RMB, forward exchange rate of RMB, domestic interest rate and American interest rates) based on Portfolio Balance Model Theory.