Effectiveness Of The Policy Of Foreign Exchange Intervention And Monetary Sterilization

Since2002, China’s international balance of payments surplus continued to accumulate, in order to maintain the stability of the RMB nominal exchange rate or orderly appreciation, China’s central bank have consistently intervened in the foreign exchange market. At the same time, central bank carried out large scale of sterilization with means like reserve requirements and open market operations to write off the effects of monetary expansion.For a long time under the approximately fixed exchange rate system and the mandatory foreign exchange settlement system, foreign exchange intervention and sterilization are always closely linked. Firstly the paper gives a thorough summarization of basic theories on sterilized intervention, then the paper analyses the institutional environment of sterilized intervention and foreign exchange reserves adequacy ratio on three international indicators to measure the status quo of China’s foreign exchange reserves, followed by a retrospection of different stages of sterilization.Subsequently, this paper carries out the empirical analysis of the effectiveness of foreign exchange intervention and sterilization. First a GARCH model based on central bank intervention reaction function is used to evaluate the effectiveness of foreign exchange intervention and the result shows that China’s intervention during January1997to December2011was effective in the sense of ironing the fluctuations in the exchange rates. Second, the sterilization coefficient and offset coefficient based on the revised BGT model are estimated for the period of January2002to December2011,the result shows a nearly complete sterilization of foreign reserve induced monetary expansion.Then, the paper calculates the profit and loss of foreign exchange intervention and sterilization separately since2003. The calculation of the profit and loss of intervention is based on Ito(2002)’s method and is divided into the forgone transaction gains/losses, unrealized capital gains/losses and interest income. The sterilization costs mainly come from open market operations and reserve requirement cost.Finally, based on the conclusions that are given in the previous sections and the entire process of sterilized intervention, this paper gives relevant suggestions including:reducing the balance of payments surplus, the regulation of international capital flows, expansion of the range of exchange rate fluctuation zone, the implementation of voluntary foreign exchange settlement, the establishment of foreign exchange stabilization fund, the development of the bond market and finally the internationalization of the RMB.