Real Exchange Rate Anomalies in China: Sterilization by the People and Trade Liberalization
When a fixed exchange rate country is faced with a sudden increase in foreign exchange inflows, its economy would normally experience higher inflation and real exchange rate appreciation. Between 1998 and 2006, however, China underwent a period of surging influx of foreign exchange and accumulation...
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| Format: | Article |
| Language: | English |
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People & Global Business Association (P&GBA)
2015-12-01
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| Series: | Global Business and Finance Review |
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| Online Access: | http://www.gbfrjournal.org/pds/journal/thesis/20151223152843-5JU6V.pdf |
| Summary: | When a fixed exchange rate country is faced with a sudden increase in foreign exchange inflows, its economy would normally experience higher inflation and real exchange rate appreciation. Between 1998 and 2006, however, China underwent a period of surging influx of foreign exchange and accumulation of vast reserves with little inflation or changes in the real exchange rate. Instead of sterilization by the central bank, this paper argues that the small change was largely due to “sterilization by the people”—the public voluntarily increased their holdings of monetary balances because of a rise in income or change in preferences—hence alleviating the inflationary pressure on the economy. In addition, the easing of import restrictions also helped offset some of the extra foreign exchange coming into China. An open economy model that highlights the role of the monetary approach is used to demonstrate how increased money demand and trade liberalization can mitigate the impact of the inflows on the domestic price level and the real exchange rate. |
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| ISSN: | 1088-6931 2384-1648 |