Excess Liquidity And The Choice Of China's Macro-economic Policies

July 21st, 2005, China announced to use a floating FX rate system with management that based on supply and need in the market, and be adjusted referring to the "Basket of Currencies". Moreover, after that, China faces with a lot of imbalance problems like trade surplus, foreign reserve increasing, excess liquidity and also the pressure of RMB appreciation.In the 1980s', Japan has had similar experience with China. Because of the serious imbalance of foreign trade between America and Japan, America government started to push Yen to appreciate. Since "Square Agreement" in 1985, Yen started to appreciate: from 239:1 in 1985 to 80.15:1 in 1995. The government of Japan used low interest rate policy, tried to avoid stagnancy of economy, but lead Japan into the "Liquidity Trap"; The appreciation did not improve the surplus of foreign trade, expectation of future appreciation was still strong, that made the interest rate even lower; The excess liquidity had no way to invest, so they all flow into the stock market and real-estate market, making the bubbles grew bigger; Lots of capital also flew out of Japan, decreasing the investment need of domestic market. With ineffective currency policy and troubled fiscal policy, it's hard for the government of Japan to stimulate the economy. Japan had experienced the economic depression for almost 10 years. How to avoid the same thing happens to China? We have a lot to learn from Japan's experience.In fact, those imbalance problems China faces with have internal connections and influences among them. Trade surplus, the expectation of RMB appreciation lead to the foreign reserve increasing, which causes the money supply and that is the major reason of excess liquidity. If the problem of liquidity can not be solved comfortably, it will cause further problems in China's macro-economic.Therefore, This paper tried to analyze Japan's lesson and give advice on treatment of excess liquidity in China. The 3rd and the 4th chapter are the most important ones in the paper. The 3rd chapter discussed how to release the pressure of excess liquidity from its causes. In addition, the 4th chapter discussed the choice of macro-economic policies for China to cope with the imbalance, especially excess liquidity, in the process of RMB appreciation.In the 3rd chapter, the paper analyses the basic causes of excess liquidity in China. It pointed out that the expectation of currency appreciation and the trade surplus were the basic causes of excess liquidity. According to Japan's experience, trade restructure, appreciation expectation's elimination and the control for the flow-in of "Hot Money" are necessary things to do.In the 4th chapter, the paper analyses the experience of Japan's fiscal and currency policies from 1985-2000. Japan's economy was hard to resurge because the invalidation of currency policy and the difficulty of fiscal policy. Learning from Japan's experience, China should insist the flexibility, independence and effectiveness of currency policy to avoid excess liquidity, and use expanding fiscal policy to offset the negative impact of RMB appreciation. What is also important is to keep the stable of RMB exchange rate.