Research On The Validity Of The Exchange Sterilization After China’s Foreign Exchange Reform

People’s Bank of China reformed the RMB exchange rate formation mechanism on2005, from that time on, the RMB begins to appreciation with steady steps. However, international trade surplus of China increase rapidly; at the same time, China’s rapid economic development absorbs a large number of foreign investment. Although the central bank permits businesses and individuals to keep a portion of foreign exchange, they still want to change their foreign exchange into RMB because they lack enough knowledge and capacity to manage the risk of the foreign exchange. Therefore, the inflow of foreign capital will inevitably lead to the increase of foreign exchange reserves, the central bank passively issue currency. In order to restrain the pressure of inflation and boost the economic development, the central bank must sterile the funds outstanding for foreign exchange. However, how to measurer the validity of the foreign exchange sterilization, whether China’s foreign exchange sterilization achieves expect objective, how long does it take to affect the target variable, these issues deserve our further thinking.This paper research on the validity of the exchange sterilization after China’s foreign exchange reform, the reason is that in this period the RMB appreciate steadily, the increase of foreign exchange reserves lead to excess liquidity, by research on this period we can have a comprehensive understand of China’s foreign exchange sterilization practice. To test the effectiveness of the foreign exchange sterilization, this paper use price stability as the standard to build the model, then use the model to test the effectiveness of China’s foreign exchange sterilization. The test result shows that China’s foreign exchange sterilization is basically effective, sterilization operations reduce inflationary pressures. At the same time, this paper uses VAR model to examine the relationship between foreign exchange sterilization and CPI, the test results show that the foreign exchange sterilization significantly keep the CPI from rose, and the effect lasts a long period. Finally, based on the test results and problems, this paper gives some proposal. In order to create favorable conditions for economic development, it is necessary for the central bank to improve market conditions as well as to adjust China’s foreign exchange sterilization policy choices, so that the central bank will have better anti-inflationary effect in the future.