The Central Bank's Foreign Exchange Intervention And Sterilisation In China

Under current international and domestic situation, in order to maintainstabilization of Renminbi nominal exchange rate and to promote a steady growth ofmacro-economy, the People's Bank of China put in place operations such as foreignexchange intervention and sterilizing operation in foreign exchange market anddomestic open market, however, lots of problems, such as continued rapid growth offoreign reserves and excess liquidity, arise. How to operate the intervention andsterilization effectively, and ensure the independence of monetary policy as well asthe balance of both internal and external economy, have become a common concernof all parties including the authorities and academia.The central bank of China's foreign exchange intervention and sterilizationwould be the study subject in this paper, mainly including theoretical summary, theempirical inspect and the transmission mechanism of sterilizing intervention, theeffectiveness of foreign exchange intervention, the cost analysis of sterilizingintervention, as well as polity recommendations.This paper first gives a summary of basic theory of central bank's foreignexchange intervention and sterilizing operation, then after a brief review of suchoperations in other countries, it makes an analysis in detail of sterilizing interventionoperations of China's central bank, based on macro- background (including exchangerate forming mechanism and foreign exchange management system) and specificoperation (including foreign exchange intervention and sterilizing operation).According to analysis in this paper, there is basically no corresponding Microfoundation of transmission mechanism of sterilizing intervention in westerntheoretical framework, which, therefore, is not suitable for analyzing situation inChina. As sterilizing intervention is one of the monetary policy operations, this paperintroduces an empirical analysis on China's transmission of sterilizing intervention,using co-integration and Granger causality test. It comes to a conclusion that in thetransmission process, money supply channel and credit channel are of highesteffectiveness, followed the exchange rate channel, and the interest rate channel andasset price channel cannot work on the whole.Based on actual conditions in China, this paper has improved event-studyanalysis of Fatum and Hutchison (2006) in two ways. It does non-parameter test of relative data on China's central bank's foreign exchange intervention, and introducesstability test with loose assumptions, finding China's sterilizing intervention isineffective, given the successful intervention standardâ… (Fatum and Hutchison, 2006).However, after parameter test with the same data, it is totally effective according tostandardâ…¡(exchange rate stabilization), which is consistent with current objectiveof monetary policy.According to the research method of Murry (1990) and Ito (2002), this papercalculated the profitability of foreign exchange intervention operation as well asChina's sterilizing cost. Then it gives a qualitative analysis of the macro-economiccost and revenue of China's sterilizing intervention, together with a quantitativecalculation of opportunity income of avoiding financial crisis in China, which is donein light of research method made by Hutchison and Neuberger (2002). Summarizingcost and revenue both in Micro- and Macro- levels, combining central bank'sintervention objective, this paper indicates that though China's central bank'ssterilizing intervention is profitable in Macro- level, it will not persist because of highcost of the operation.At last, this paper gives policy recommendations on foreign exchangeintervention, sterilizing intervention and policy cooperation, in light of the conclusionand causal analysis of empirical study mentioned above, referring to foreignexperience and actual condition in China, on purpose of dealing with problems suchas blocked monetary policy, high cost of sterilizing intervention operation andunsustainable sterilization operation, etc.. Those recommendations includes amendingobjectives of foreign exchange intervention, improving intervention methods, andestablishing exchange stabilization fund; coordinating with interest policy, and playthe role of OMOs; reforming exchange rate policy and foreign exchangemanagement system.