On The Effectiveness And Sustainability Of The Central Bank Bills Reversed

Due to successive surplus in both current account and capital account, China's foreign exchange reserve grows sharply. PBOC has carried out sterilization operation by issuing central bank notes, in order to keep the stability of RMB and control domestic money supply. Based on Portfolio-Balance Model and past practice of China's sterilization operation, this article verifies the effectiveness of central bank notes in controlling domestic money supply through structuring VAR model, applying Granger causality test and impulse analysis. Further, this article points out that issuing central bank notes continually may cause serious negative influence, e.g. bringing about vicious cycle, interfering independence of monetary policy and pulling up domestic interest rate. On the other hand, while experiencing dynamic financial reform, the assumption of effectiveness in sterilization operation will no longer exist in China's market. So the article concludes that central bank notes'effectiveness can't persist in China. Finally, this article puts forward several suggestions for improving sterilization operation in China.