| In the debate on floating exchange rate regime and fixed exchange rate regime, although the focus and perspective are different at different times, the advocators for floating exchange rate regime all agree: monetary policy has autonomy under floating exchange rate regime. This point of view is also popular among economists and policy-makers nowadays. Nevertheless, this paper finds out a problem in the above common point: it hasn't taken currency substitution into consideration, because during the 1950s and 1960s real economy accounted for the large part of the whole economy, whereas financial economy took a small part. Currency exchanges in foreign exchange market were mainly caused by international trade, capital flow wasn't large-scaled, thus currency substitution was not frequent and pervasive phenomenon. However, at the present time, with the expansion of financial assets, the structure of world economy has undergone substantial changes. Financial economy outgrows real economy, the turnover in foreign exchange market is far more than that in international trade, and a large part of foreign exchange transactions is to serve capital flow. Capital flow is sensitive to interest rate and foreign exchange rate, a small spread may lead to large-scale currency conversion and arbitrage activities. Therefore, under these circumstances, currency substitution has become an undeniable reality. The question is: when taking this factor into consideration, does monetary policy have autonomy under floating exchange rate regime?The research on this question not only has theoretical implication, more importantly, it also has certain reference value for China's choice of exchange rate regime. The current exchange rate regime in China is known as "managed floating exchange rate", but banks firms and individuals can not hold foreign exchanges according to their will and the mechanism of exchange rate determination is closed and regulated, so present regime is infact a fixed regime pegged to Dollar. This regime has many defects: inefficient, risky and costly, therefore should be reformed. In the long term, China should choose floating exchange rate regime. However, in the process of China's further financial opening-up, if we directly employ floating exchange rate regime, currency substitution would greatly weaken the independence of monetary policy, which is quite important for China. If monetary policy can not be used independently to intervene with macro economy, the stability as well as development of China's economy will be adversely affected and strategies such as Western Development will be greatly restrained. It can be seen that monetary autonomy is indispensable for China in the transitory period and so must be considered in the choice of exchange rate regime. From this perspective, what exchange rate regime should China choose? This paper is structured as follows:First, it gives the definition of and factors affecting currency substitution. Currency substitution means large-scale currency exchanges due to lack of confidence on native currency or the comparatively low return on native assets, so that foreign currency completely or partially replace native currency in store of value, medium of exchange and standard of pricing. Many western countries have experienced currency substitution after free currency conversion and some developing countries had the similar experience during economic liberation in 1970s and 1980s. People began to explore the factors influencing currency substitution so as to find a solution. These factors include: inflation rate, national income, political risk, market condition, institutional development etc.Second, it provides two relevant models as the general framework. The model of Miles (1978) is simple and classical, which indicates that in the situation of free currency conversion and floating exchange rate regime, the increase of money supply in one country will lead to currency flow between two countries because of currency substitution, and this cross-country... |
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