The Conflict Between Monetary And Exchange Rate Policy In An Open Economy

All along, when the scholars explain the conflict between monetary policy and exchange rate policy, they take either Mundell - Fleming or Krugman "impossible triangle" model as their references. In practice, many countries like China choose the middle exchange rate system or imperfect capital mobility framework, thus these models are not suitable in real practices. This paper tries to give a new explanation to the conflict by introducing a model of expected rate of return of asset portfolios and combining the practices of policy conflicts in China since 1994. Under the middle exchange rate system, the fluctuations of expected rate of return in portfolios denominated by foreign currencies can incur the speculation shocks and have an impact on the monetary policy independences. Based on the above analysis, the paper tries to outline some policy implications. The paper is mainly composed of five parts:The first part reviews the classical theories of monetary and exchange rate policy conflicts. It starts with the explanations of linkages and transition mechanisms between monetary policy and exchange rate policy. Then the paper will analyzes the relevant theories of policy conflicts as the theoretical bases of further new explanations.In the second part, the paper will give detailed explanations about the features of Chinese economy, particularly about the historical transitions of Chinese monetary and exchange rate policies and the current policy arrangements. This can help us to understand better about the conflicts of Chinese monetary and exchange rate policies.Part 3 will cover the analysis of monetary and exchange rate polices in current China. It will first review briefly about the historical development of monetary and exchange rate policies in China. It then discusses the conflict of policy policies since 1994 and have some further discussions.The fourth part is the core of this essay. It introduces an expected rate of return model of asset portfolios and does the empirical studies. Firstly, it gives theoretical analysis about the influences of expected return changes. Then, by combing with the Chinese practices, the empirically tests about the suitability of the model and summarizes the conclusions.In Part 5, the paper presents further discussions of monetary and exchange rate policies. According to the macroeconomic conditions of Chinese economy, the paper outlines the relevant policy implications.