A Study On Twin Surpluses Of China's BOP And Independency Of Monetary Policy

The globalization has strengthened the economic ties between countries all over the world. As a result, international trade and capital flow have greater impact on domestic economies. During 2006 and July, 2008, China suffered from rising CPI, while the accelerating accumulation of twin surpluses forced the monetary authorities to inject more liquidity into economy. After the economic recession, pressure on monetary policy has alleviated. However, as the world economy recovers and huge amount of money issued during the financial crises, it is still of great importance to study how to maintain independence of monetary policy in open economy in advance.This paper goes through the theories on the influence of open-up on monetary policy. In classical economic theory, the economy realizes equilibrium itself under the assumption of flexible price. In Keynesian Economics, the impact of international trade and flow of capital are analyzed under the assumption of rigid or sticky price. In new Keynesian Economics, micro foundation and monopoly price are focused; therefore, the mechanism is becoming more and more complicated. Based on the above theories, this paper then analyses the situation of China in international trade and capital flow, and their influence on monetary policy and its conduction.This paper also examines the mechanism weakening the independence of China's monetary policy in the open economy. Granger causality test fails to reject the Null Hypothesis that the change the rate gap between China and the U.S. and the change of position for forex purchase don't have bi-direction granger causality, while the change of position for forex purchase is the granger causality of the change of monetary base. The nominal effective exchange rate of RMB, the balance of current account and the monetary base have co integration relation. The impulse responses and variance decomposition of RMB based on the VAR model reveals that the monetary base is its own major influencing factor in the short term while the balance of the current account in the long run. Therefore, the foreign exchange is the main reason of lacking independence of China's monetary policy. At last, suggestions are put forward in four aspects:enhancing open market operation by conducting bond market construction, reducing sterilization pressure by deepening reform of exchange rate, decreasing twin surpluses by economic restricting and increasing efficiency of monetary policy by developing financial market.