Study On The Optimal Scale Of Chinese Foreign Exchange Reserves

The foreign exchange reserves of China increased very fast in the recent years. The amount of the foreign exchange reserve surpassed Japan in Feb,2006 becoming the country owned the most foreign exchange reserves. The amount reached 1 trillion dollar in Oct,2006 and the increased amount was over 400 billion dollar in 2007 and 2008. The amount was nearly (?)2 trillion in the end of 2008 and increased to (?)2 trillion in Apr,2009. The foreign exchange reserves can promote the developing of the economy but there are still some critical problems we can not neglect. The surplus of foreign exchange reserves can bring to liquidity surplus, pressure inflation and the difficulty in implementing monetary policy. As the foreign exchange reserves increase rate overpass the normal level, the supply of the reserves is larger than the demand which lead to the appreciation of RMB and the depreciation of the foreign exchange reserves. Considering the loss the surplus of foreign exchange reserves bring to China, it is crucial to tackle with this issue.We still do not have a uniform standard of the proper scale of foreign exchange reserves. At present there are some methods that accepted by the theoretical area including ratio analysis, demand analysis, cost-return analysis and qualitative analysis. All of the analysis have advantages and disadvantages. These analysis have been used in general to calculate the proper scale of foreign exchange reserves. Compare with the scale that calculated by the model, most of the researcher conclude that the present amount of foreign exchange reserves is excessive.In this dissertation, the author uses a model differ from the traditional model the cross phase model. This model is first used to calculate optimal foreign exchange reserves by Ranciere and Jeanne (2006). The development of economy is a dynamic progress. Foreign exchange reserves in different phase have effect on the economy. This model divided the economy into two part:the individual department and government department. We need to consider the different effect of the two department and maximize the welfare so as to conclude the optimal foreign exchange reserves. Ranciere and Jeanne (2006) created this model to calculate the optimal scale of the emerging market. In this dissertation, the author use this model and make some change to adapt the condition of China. One of the most important contribution of the model is to quantify the level of reserves that can be justified as an insurance against capital flow volatility.India and Japan are both representative countries in Asia. India is the largest developing countries excluding China. Japan is the most developed countries in Asia. Both of their foreign exchange reserves are top ranking. Before 2008, Japan is the countries that possess the most foreign exchange reserves. We can learn some experiences from the two countries when compare them with China. This dissertation promotes some suggestions about the regulation of the Chinese foreign exchange reserves management based on the increment and inventory.