Study On The Effectiveness Of China's Foreign Exchange Sterilized Intervention

Since the nineties of the 20th century,"Twin Surpluses"(Current Account Surplus and Capital Account Surplus) have increased drastically in China's Balance of Payment. Foreign exchange reserves have been increasing in a big margin. In order to maintain stability of exchange rate, the central bank needs to buy foreign exchange reserves in the foreign exchange market at the same time putting out basic currency in domestic market. Money supply from foreign exchange becomes an outstanding issue. The high foreign exchange reserves will lead to a large number of foreign exchange shares in base currency, thus a direct impact on base currency. The base currency which is influenced by multiplier effect will lead to the surge of domestic money supply and the rise of prices. The rapid increase of foreign exchange also influences the initiative of central bank which implements monetary policy.The central bank of our country has to carry out the sterilized intervention. The purpose of monetary sterilization is to keep the stability of domestic money supply, achieve monetary policy target and insure the independence of China's monetary policy. This paper researches effectiveness of China's foreign exchange sterilized intervention.First, this paper analyzes the current situation of the foreign exchange reserves, funds outstanding for foreign exchange and the base currency. Second, researches the foreign exchange sterilized instruments used in China since 1994 and establishes a reaction function of the central bank to test the effectiveness of sterilized intervention. Empirical research illustrates that the sterilization of central bank in china is effective. But it is not so efficient. Eventually according to the analysis, this paper gives some political suggestions on how to advance the policy of monetary sterilization.