The Research On The Relationship Between Foreign Exchange Reserves And Inflation Of China

From the reform of China, our country is more open to the foreign country than before. Because the balance of payments has been surplus for recent years, the foreign exchange reserves have been much more than before. At the year of 2006, China becomes a country who possesses the most amount foreign exchange reserves. At the same time, the economic situation is flourishing and the supply of money is increasing. So some economists worry about another inflation cycle of economy coming. When the effect of the outside economy becomes stronger than before, people pay more attention to the relationship between foreign exchange reserves and inflation. In our foreign exchange system, how much the effect on the increasing of foreign exchange reserves affects the supply of money and then form the pressure at the price is a problem which is worth to research.From the reform of foreign exchange system, our country establishes the single and fixed foreign exchange system. The exchange rate of RMB was decreased by 33 percent and the exchange rate (USD to RMB) was from 5.8:1 to 8.7:1. At the promotion of the inside economy and a lot of encouraging export policies of China, the balance of payments occurs some big changes. According to the statistic, in 1994 the amount of current account was 7.66 billon dollars, and the surplus of the trade account was 7.28 billon dollars. The surplus of the capital account was 32.64 billon dollars which was more than the amount of 1993. At the fixed foreign exchange system, a great deal of the surplus of the balance of payments certainly was responsible to the surplus supply of the foreign exchange reserves among the banking businesses. In order to make the exchange rate of RMB stable, the People Bank of China entered into the foreign exchange market to sell or buy the foreign exchange reserves. Because of this operation, the asset structure of People Bank of China was changed and the supply channel of the base money was also changed. The growth of foreign exchange reserves became one of the most important channel to put base currency into circulation. In order to assure the amount of money supply be stable, People Bank of China had to carry out the sterilization policy. The main means of this policy was withdrawing the loan which was lent to the commercial banks.Although the foreign exchange reserves system which is mainly contained USD dollars is good for the exchange rate being stable and ensures the ability of foreign payment, it also makes the central bank difficult to perform the money policy. Whether the relationship between the foreign exchange reserves and inflation exists is a problem which we will discuss in the following chapters. In this thesis, we use the qualitative analysis and quantitative analysis means to expound the relationship between them.The main idea and structure of this thesis is arranged as following: first, from the perspective of analysis the reason for foreign exchange reserves influencing money supply, elaborates the influence of foreign exchange reserves to the economy conditions of our country; second, expounds the theoretical reasons and methods and effects of this sterilization; then explains the specification of foreign exchange sterilization policy; finally analyzes the reality requirement, current status, problems and future of our country's foreign exchange reserves.This thesis consists of four parts, the structure and content as follows:The first chapter is a theoretic summarize which contains some relative theory, it is a theoretic base of this thesis. In this chapter expounds the influence elements of the money supply. These elements mainly contain two parts: money multiplier and base money. Then analyses the mechanism about the foreign exchange reserves how to influent the price. In order to expound this mechanism, this thesis presents the definition, measurements and the cause of the inflation. According to theses research, we can summarize two standpoints: some people consider the foreign exchange reserves have relation to the inflation, while some people think they do not have relationship.The second chapter introduces the trend of the foreign exchange reserves, money supply and the price in our country. This chapter contains three aspects: 1.explians the difference and relation between international reserves and foreign exchange reserves; 2.analyses the changes of the foreign exchange reserves, including the scale and the management system.The third chapter is a quantitative analysis part. Based on the existing statistic data, the paper carries out study about the relationship between the foreign exchange reserves and the prices thoroughly since1994. The paper studies the stability of the economic series including the foreign exchange reserves and inflation rate. We draw the conclusion that the foreign exchange reserves can promote price in a long-term with the application of co-integration on the relationship between foreign exchange reserves and the prices.The fourth chapter discusses the measurements which be used to reduce the inflation pressure. These measurements contain following aspects: first, reinforcing the reform of foreign exchange system, distributing the foreign exchange reserves reasonably; second, taking full advantage of open market operation; third, adjusting the economic development policy to make the balance of payments accord with the demand of the whole economy; fourth, constructing the financial market basis for central bank performing money policy; last, making use of foreign exchange reserves reasonably.The thesis has following characters: First of all, not only bases on the theory, but also relates to the actual situation of our country. The analysis method combines qualitative and quantitative means. Two methods testify the foreign exchange reserves and inflation have co-integration relationship. But most of all, in this thesis using the econometric model testifies how strong relationship between foreign exchange reserves and inflation, and also represents the casual relationship between of them. Second, analyzes the endogeneity of money supply from a new aspect by organically combining foreign exchange reserves with money supply. The thesis points out that the central bank should pay attention to the foreign exchange reserves to control the money supply to relieve the inflation pressure.