Theoretical And Empirical Study Of The Relationship Between Foreign Exchange Reserves And Inflation In China

Along with China's foreign exchange system reformed in 1994 and the rising degree of open market policy, the balance of payments has been consistently surplus and the foreign exchange reserves have been much more than before. The foreign exchange reserves of our country have risen sharply to 2840 billion dollars. China has become a country who possesses the most amount foreign exchange reserves. Certain amount of foreign exchange reserves could ensure the safety and the stability of exchange rate system, reinforce the ability of foreign payment and the exchange rate being stable and enhance the comprehensive strength of our country. However, excess foreign exchange reserves are detrimental to internal economic regulation. The central bank purchases foreign exchange reserves in foreign market passively out of the need of stabilizing exchange rate and increases the base money input, which gives more pressure to the price. The article is based on economic theory and econometrics for the analysis tools, does qualitative quantitative analysis on the relationship between foreign exchange reserves and inflation.The thesis at first analyses the changes of foreign exchange reserves and inflation, and then analyses the transmission mechanism between foreign exchange reserves and inflation systematically in theory:balance of payments surplusâ†'the net foreign assets↑â†'foreign exchange reserves↑â†'funds outstanding for foreign exchange↑â†'base currency↑â†'the money supply↑â†'inflation (rising prices). In addition, the paper uses statistical data of 2001-2010 to demonstrate that the increase of foreign exchange reserves does have a deep effect upon inflation. The pulling effect of foreign exchange reserves on inflation is 0.030712 in the long-term. The increase of foreign exchange reserves has a positive impact on inflation in the first three period in the short-term and the effect has long-lasting influence. Further more the thesis has another discover that the rapid economic growth has a greater effect on inflation. To reduce the pressure on inflation, the paper discusses the policy recommendations:reinforcing the reform of foreign exchange system, improving policies of foreign exchange reserves intervention and adjusting the economic development policy to make the balance of payments according to the demand of the whole economy.