The Cost Of Offsetting Policy And Sterilisation In China

Since 1994, double surpluses (current account surplus and capital account surplus) have appeared in the balance of payments of China. For the purpose of maintaining the stability of RMB exchange rate, the People of Bank of China (PBC) began to intervene in the foreign exchange market to sell RMB and buy foreign assets. Due to the sustained accumulation of the foreign reserve, the base money was forced to increase rapidly. In order to control the money supply and prevent high inflation, PBC has used some monetary policy instruments to sterilize the passively expanded money supply driven by the double surpluses. This article not only analyzes the history of sterilization policy from 2000 to 2009, including the degree of sterilization, the objective of sterilization and the effectiveness of sterilization, but also explores the sustainability of sterilization in the future.This article includes the following five chapters. In the first chapter, we introduced the research background, reviewed the main research results and methods in both the domestic and international literatures, and described this paper's innovation main innovation and weakness. The second chapter summarized the overall condition of PBC's sterilization policy, introduced a theoretical framework conforming to China's specific national situation, and described the empirical method of this article, namely Structural Vector Auto Regression (SVAR). In the third chapter, the article used SVAR model to analyze the degree and objective of sterilization policy from January 2000 to May 2009. The empirical results show that PBC implemented an active sterilization policy, which aimed to sterilize the capital inflow instead of current account surplus. Moreover, there was no evidence of "offset effect" in China. The fourth chapter focused on the effectiveness of sterilization policy and we concluded that the sterilization intervention by PBC managed to neutralize the passively expanded base money effectively, but monetary policy was not completely independent because the money supply was influenced by foreign reserve accumulation in the short run. In order to explore the sustainability of the future sterilization intervention, the fifth chapter analyzed sterilization cost as well as the impact of sterilization cost on decision-making process of PBC. Through estimating the dynamic relations between sterilization intervention and sterilization cost, this article found that PBC considered sterilization cost and its financial strength in making a sterilization decision. Faced with larger foreign reserve inflow, PBC decreased the domestic interest rate to reduce sterilization cost. In addition, PBC strategically lowered the degree of sterilization when sterilization cost was higher and vice versa. Based on our empirical research, we concluded that with the perfection of China's financial system, it will be difficult for PBC to implement the sterilization policy persistently. In the end, this article made a conclusion of PBC's sterilization policy.