China's Foreign Exchange Reserves Of The Effects Of Inflation

As the increasing openness of Chinese economy, changes in foreign exchange reserves have become the linkage between economic, financial and monetary policies of domestic and that of foreign countries, and are closer with our macroeconomic. For China which is in the process of transformation, the dual-continuing surplus of the current account and capital and financial account make our foreign currency reserves increasing in the current foreign exchange management system. Ended in June 2006, China's foreign exchange reserve has reached 941.115 billion U.S. dollars, surpassing Japan as the country holding the world's largest foreign exchange reserves. In April 2009, it reaches to 2 trillion U.S. dollars, then to 2.399152 trillion U.S. dollars in the end of this year, accounting for 30.7% share of the world reserves. Such huge foreign exchange reserves not only meet the needs of China's adjustment of international imbalances, external payments capacity, stable foreign exchange market and the maintenance of international credit, but also adversely affect the domestic economy. One aspect is the central bank put more and more basic money through the Foreign Exchange Reserves channels. In 2002, China's Foreign Exchange Reserves reached 2.322334 trillion yuan, accounting for 51.45% of total base money in the same year, this proportion continued rising in the following years. And to 2005, it ups to 110.67%, which indicates that China's basic monetary pattern has undergone significant changes, foreign exchange reserves have become an important factor in the money supply. The excessive foreign reserves increased the costs of sterilization operations of central bank, weaken the independence of central bank's monetary policies, and increased the inflationary pressure in China. Under the current foreign exchange system, whether the foreign exchange reserves have a significant impact on the price level and to what extent if it exists, how the relationship between the two, all of these are worthy of further investigation.This paper will study the relationships among China's foreign exchange reserves, money supply and price level. Firstly, this paper discusses the theoretical relationship between foreign exchange reserves and price level, and then analyzes the transmission mechanism of foreign exchange reserves'impacts on the price level under the current China's foreign exchange system. Lastly, this paper uses econometrics knowledge and Eviews5.1 to make a detailed empirical analysis of the relationship between the two above. As it can be seen from the results of the impulse response, the China's foreign exchange reserves have lagged effects on price level and the short-term effects are limited, the mainly reason is that China's central bank carried out high-volume short-term foreign exchange sterilization. However, in view of co-integration and causal analysis, there indeed exists co-integration relationship between China's foreign exchange reserves and the price level, and the former is the Granger-causality of the latter, which means our foreign exchange reserves will give pressure on inflation. Facing the huge foreign exchange reserves, China needs to build effective measures to mitigate inflationary pressures, such as consolidating the basis of the foreign exchange market and money market, increasing open market operation of the central bank, further reforming foreign exchange management system, floating exchange rate moderately and using our existing foreign exchange reserves fairly.