A Research On How China’s Foreign Exchange Reserve Has Affected Inflation

Since the reform of the RMB exchange rate system in1994, under the influence of the dual surplus of balance of payments in China, the foreign exchange reserve of our country is growing rapidly and continually. The main source for the rapid growth of China’s foreign exchange reserves is the dual surplus of the current account and capital and financial account. Huge amounts of the balance of payments’surplus bring many problems to China such as the increasing of money supply and inflation with the excessive foreign exchange reserves. The direct result of China’s balance of payments dual surplus is the fast rising CPI and investment ratio. Money supply is a very material variable in a country’s macroeconomic and it is the root of the change of domestic price index. The influence which the balance of international payments has on money supply can be directly reflected by the fluctuations of the price index.The different source of foreign exchange reserve has different economic meaning that lead different impact to money supply. Using the theoretical analysis and the empirical analysis methods, the thesis firstly analyzes the status quo of the source of foreign exchange reserve. Secondly, analyze the change of the source of foreign exchange reserve, especially the influence which the source of foreign exchange reserve has on the inflation via the path of the current account and capital and financial account. The dissertation concludes that the impact capital and financial account has on the inflation is more significant than the current account, although the latter’s amount is lager. Then, by establishing a model on the basis of co integration theory, the results of empirical study make out that the balance of imports and exports and foreign direct investment which as the major source of foreign exchange reserve are both the reason of inflation. However, the impact which the foreign direct investment has on the inflation is more significant. Finally, on the basis of China’s state quo, the paper puts forward some countermeasures to eliminate the impacts that the major source of foreign exchange reserve brings to inflation. We should optimize the source of foreign exchange reserve, quicken the step of import and export trade’s restructuring and upgrading and improve the RMB exchange rate reform.