The Research For The Relationship Between China’ Foreign Exchange Reserves And Money Supply

The foreign exchange reserves is the material guarantee of resistance international financial risk, and of vital importance in the area of international financial research. After Southeast Asia Financial Crisis, most of the countries have increased their foreign exchange reserve in case of financial crisis. It has been paid more attention to a country’s foreign exchange reserve.Since the reform of the foreign exchange management system, China’s foreign exchange reserves have maintained sustained, rapid growth. After the financial crisis of Southeast Asia, it is growing more rapidly, from＄144,959,000,000 in 1998 to＄1,066,347,000,000 in 2006. Trace the history of the development of foreign exchange reserves, since China adopted the unification of exchange rates, the increase of export earnings and the inflow of foreign capital has made the supply for China’s foreign exchange reserves be greater than demand for it. Because of China’s current exchange rate system, double surplus of current account and capital and financial account, in order to maintain the stability of exchange rate, the central bank’s foreign exchange reserves will inevitably lead to significant increase, in response to the central bank’s money supply is the significant increase of the funds outstanding of foreign exchange. With the continuing rise of foreign exchange reserves, the funds outstanding of foreign exchange is becoming the important way for putting in the base money. So in theory the increase of foreign exchange reserves must have a very important influence to money supply, meanwhile the money supply is determines the demand for the foreign exchange reserves as an important factor. To this end, the paper made the theoretical and empirical research from two sides which are how foreign exchange reserves affects money supply and how money supply affects foreign exchange reserves. The research conclusion is that the increase in foreign exchange reserves do promote the amount of money supply, meanwhile, at the situation of monetary disequilibrium, the movement of foreign exchange reserves is the result of these two sides, besides the foreign exchange reserves in the last period, also with the previous period’s money supply closely related.We can analyze the impact of the growth of foreign exchange reserves to money supply from the aspect of base money. Based on the analysis of simplified form of the central bank’s balance sheet, base money is constituted with domestic credit and net foreign assets. The net assets include foreign exchange, monetary gold and net assets in international financial institutions. Foreign exchange is in the form of the funds outstanding of foreign exchange. Therefore, base money can be regarded as domestic credit and foreign exchange of two parts. In an open economy, the countries which adopted fixed exchange rate system have balance of payments surplus, making the foreign exchange reserves. To stabilize the exchange rate, the central bank must buy excess foreign exchange in foreign exchange market. The RMB which is used for buying excess foreign exchange is the funds outstanding of foreign exchange. It belongs to base money. Therefore the increase in foreign exchange reserves makes the increase in the funds outstanding of foreign exchange, which leads to the increase in base money. Through the effect of multiplier the increase in base money makes the money supply increase. Not only foreign exchange reserves affect money supply from the aspect of the number and the structure of it, but also strengthen the endogenous nature of money supply in our country and reduce the delay of money supply. Model estimation of this part uses ordinary least squares estimations. The result of estimation shows that the movement of foreign exchange reserves promotes the movement of money supply in our country, and they have a significant relationship.The paper will use the thought of the Monetary Approach to the Balance of Payments, which considers that imbalance of balance of payments is resulted by disequilibria on demand and supply of money. In the country which adopts fixed exchange rate, the result of disequilibria on balance of payment is the adjustment of foreign exchange reserves turning up or down. Therefore the adjustment of foreign exchange reserves inevitably causes the adjustment of money demand and supply. Based on this analysis, the paper established a dynamic model of foreign exchange reserves from the research of Frenkel and Edwards. This model assumed that the change in foreign exchange reserves comes from two aspects. One is discrepancy between desired reserves and the amount of reserves actually held by a particular country, the other one is excess demand or excess supply of money: foreign exchange reserves will decrease if there is an excess supply for money. This is done by estimating a dynamic equation for the demand for foreign exchange reserves that inculpates monetary disequilibrium consideration.This article is divided into five chapters. The first is introduction parts. The second is introduction of international reserves and foreign exchange reserves. The third and fourth are the main points of this paper. These two parts analyze the relationship between foreign exchange reserves and money supply from the perspective of theoretical and empirical sides. The last one is the conclusion.