Theoretical And Empirical Studies Of The Impact Of China's Foreign Exchange Reserves On Inflation

Since the foreign exchange system reformed in1994, China's foreign exchange reserves were rising fast. At the end of2006, China's foreign exchange reserves surpassed Japan ranking first in the world. To the end of2010, China's foreign exchange reserves were up to$2.85trillion. The rapid growth of foreign exchange reserves was the mark enhance of China's comprehensive national strength, but also increased China's external payments and adjusted the balance of payments capacity. At the same time, with the growing of foreign exchange reserves year by year, inflation pressure of China were going up. The rising of China's foreign exchange reserves lead to increasing foreign exchange share in base money of the People's Bank of China, resulting in the increase of base money, the money supply increasing through the monetary multiplier effect, leading to price index rising in China. The rapid growth of foreign exchange reserves and movement of inflation have become the two outstanding problems in our economy. Under the regulation and control of current foreign exchange management system and the monetary authorities' macroeconomic, whether the relationship between the foreign exchange reserves and inflation exist, and what effect on inflation from foreign exchange reserves increase? This paper will have depth discussion and research on the above problems. The paper analyzed the impact of China's foreign exchange reserves to growth of money supply and inflation through the theoretical analysis and empirical analysis, and a combination of methods of qualitative analysis and quantitative analysis. First, based on the theory of base money and inflation to analyze the impact of foreign exchange reserves on money supply, due to the rapid growth of foreign exchange reserves, foreign exchange supply exceeding demand, in order to maintain the RMB exchange rate stability China's central bank was forced to buy foreign currency and sell the local currency, and became foreign exchange share in base money, in the case of domestic credit remain unchanged, the increasing foreign exchange share in base money became the main channels to put the base currency of central bank. Foreign exchange share in base money accounts for the proportion of base money in2005was more than1, and up to121.85%in2010.By a brief review of China's foreign exchange reserves, money supply and price index, to analyze the conduction mechanism of foreign exchange reserves on inflation. Money supplies consist of foreign exchange reserves and domestic credit. Foreign exchange reserves increase would cause a corresponding increase of the money supply on the condition of unchanged domestic credit. According to the quantity theory of money, when money supply is greater than the demand for money, the total social demand is greater than the total social supply, prices level will raise and lead to inflation. Although the Central Bank of China had taken actively foreign exchange write-off measures, but it was subject to the constraints of the bank loans and deposits plans to lower write-off the effectiveness of measures and initiative. When the increase in the amount of foreign exchange could not be write-off by central bank, resulting in base money increase, domestic money supply would increase exponentially, through monetary multiplier effect. In the commodities market, breaking the existing domestic money market equilibrium, the increase in money supply would ultimately lead to a rising price level. Empirical testing through the use of econometric theory and methods to analyze data from1994to2010, foreign exchange reserves increase would expand the money supply, and lead price fluctuations. The price index, foreign exchange reserves and money supply have long-term stable equilibrium relationship. The foreign exchange reserve is Granger cause of inflation. Finally, this paper presents following suggestions to relieve the pressure the foreign exchange reserves on inflation:adjust the development of the strategic and balance international payments; accelerate the establishment of the market mechanism of the RMB exchange rate; improve the foreign exchange write-off policy; transform trade growth mode and adjust the product structure; encourage enterprises to implement the "going out" strategy.