The Study On The Effects Of China's Foreign Exchange Reserves On Inflation

In recent years,China's foreign exchange reserves sustained and rapid rise,in 2006 China's foreign exchange reserves exceeded Japan as the world's largest holder of foreign exchange reserves. At the same time,China's consumer price index (CPI) also increased,inflationary pressures gradually becoming apparent.The question of relationship of foreign exchange reserves and inflation has been the focus of study at home and abroad,and different perspectives. Given the relationship of foreign exchange reserves and inflation is currently a hot issue,and there are different perspectives about this issue, as well as a wish to add on the study about this issue as the starting point,a combination of theoretical and empirical clears the relationship of China's foreign exchange reserves and inflation,to provide theory and empirical basis for China's macro-control for the purpose of the study,for the current inflation as the main goals of China's macro-control to my country,it is a matter of urgency,in the formulation of policy there is also a very important guiding significance and practical significance.For the relationship of foreign exchange reserves and inflation,the scholars at home and abroad have done a lot of research.On the number of international,as well as the International Monetary all considered there was the relation between price levels and the foreign exchange reserves,foreign exchange reserves led to a price rise. And the International Monetary proposed inflation transmission mechanism:balance of payments surplusâ†'foreign exchange reserves↑â†'currency on foreign exchange↑â†'base currency↑â†'money supply↑â†'price level↑.The study of Heller(1976) and Khan(1979)also confirmed the transmission mechanism.Many foreign scholars have pointed out that there were certain impact of foreign exchange reserves on the inflation; The studies in our country were based on the analysis of the domestic situation,there were great differences.Xiandong Yan,Keran Feng(1997) studied the prevailing inflation,considered foreign exchange reserves variable was not significant,China's foreign exchange reserves and inflation did not exist relation.Chuanlun Wang,Xiandong Yan(1998) from the data of China's foreign exchange reserves and price level studied to consider foreign exchange reserves and inflation did not exist linear relationship,but because of the sharp increase of foreign reserves,base money increased, it couldn't avoid playing a catalytic role on our prices.The studies of Rongmao Liu,Kaiyan Li(2005)pointed there was not obvious relation between the fluctuations of inflation indicator and the change of the number of foreign exchange reserves.In addition,a large number of scholars have pointed out that there were impact of China's foreign exchange reserves on inflation,the increase of foreign exchange reserves could create inflationary pressures.The theoretical analysis of foreign exchange reserves and inflation is studied from monetary analysis of the balance of payments and the assumptions of overshoot model. BoP monetary analysis starts from the theoretical formula of the money demand and money supply,it comes to the significant conclusion,a country's foreign exchange reserves is positively correlated with the real income growth rates and domestic inflation rates. Based on the analysis of Overshoot model assumptions it indicates,in the long run, how much money supply growth has led to how much inflation pressure.It proves that in a long term the transmission mechanism of"foreign exchange reserves increase—money supply grow—price level rises(inflation)"exists.To study the relationship of China's foreign exchange reserves and inflation,in the modol the empirical variables selected the following three variables are: P is the price index; Fr is a country's foreign exchange reserves; Ms is the money supply. The consumer price index (CPI) is instituted by general price index in the modol;foreign exchange reserves is balance at the end of the year;money supply is M2 in the modol.The paper selects China's 1981-2006 the last 26 years of statistical data to study.This paper has taken a large number of econometric models and algorithms and introducts their basic principle. First of all,it's variables unit root test to test the stability of the variables,and then the establishment of VAR model,the impulse response to study variables'reaction when are impacted by other variables,then uses Johansen cointegration test to test variables long-term equilibrium relationship, on the basis of cointegration establishes VEC model to study the impact of short-term fluctuations.The unit root test of variable sequences indicate the sequences are I(1) sequence. After the establishment of three variables VAR model,the paper does the analysis of impulse response.The impulse response of the impact of foreign exchange reserves and the money supply on price level indicates when there are the positive impacts of foreign exchange reserves and the money supply,price level has the same response; The impulse response of the impact of foreign exchange reserves on the money supply indicates when there is the positive impact of foreign exchange reserves, the money supply has the same response.This shows the inflation transmission mechanism exists.Then Johansen cointegration test of the three variables long-term stable relationship indicates trace test and maximum eigenvalue test all show that at 95% confidence there is a cointegration equation.This shows there is long-term and stable relations between the general price index,foreign exchange reserves and the money supply. Through cointegration equation we can also see that the foreign exchange reserves and price index show a positive correlation;the money supply and price index are also strong positive correlation,at the same time also shows that the money supply has a strong multiplier effect. VEC model is established on the basis of cointegration,and the model's overall results is good.From the vector error correction equation can be seen,when in the short term deviation from the long-term balance of foreign exchange reserves and inflation, the price will not respond quickly,that is the impact of long-term balance on short-term fluctuation is not significant,in the short term stable relationship of the long-term balance is not obvious. At the same time,it can be seen from the vector error correction model,Δp ( ?1),Δms(?1)passed the test,but did not pass the test. Therefore it can be considered:the previous year's inflation rate affects the current inflation rate significantly;the previous year's growth rate of foreign exchange reserves affects insignificantly the current inflation rate; the previous year's money supply growth rate significantly impacts on the current inflation rate, and the largest contribution rate. This shows that the short-term fluctuations of prices is mainly affected by other variables,such as the previous year's inflation rate,as well as the previous year's growth rate of the money supply, however the impact of the previous year's growth rate of foreign exchangeΔfr(?1) reserves on short-term fluctuations of prices is little.We chose representative 1995-2004 annual data of China's central bank to analyse and interpret that the empirical conclusions that the impact of foreign exchange reserves on inflation is little in the short term. Can be seen from the fact that, in the short term,there was no great increase in prices when foreign exchange reserves increased.The central bank's measures of the change of government departments, financial institutions and nonfinancial institutions net claims, open-market operations of treasury bonds and issuance of central bank bills were effective. So in the short term foreign exchange reserves'increase did not lead to proper inflation,while the money supply can be controlled through the central bank's intervention policy,that reduces inflationary pressures.So in the short term the impact of foreign exchange reserves on inflation is little. This conclusion is in line with the status of our country's macroeconomic development.However,with the central bank's offset measures'difficulty gradually increasing,as well as the negative impacts of measures gradually deepening,the central bank's policy cannot to be used for long term, and intervention is short-term, then the phenomenon that foreign exchange reserves'increase leads to inflation pressure in the short term will become increasingly evident. Finally,the paper analyses the reason for China's current inflation,it is caused by our country structural factors, and the impact of increase of foreign exchange reserves on current inflation is little.