The Study On International Capital Flows And The Effectiveness Of Monetary Sterilization In China:2000-2012

China has gone through Double Surplus (i.e. current account surplus and capital account surplus) since 2000. As a country with net inflow of international capital, RMB has been under the pressure of appreciation for a long period. The central bank needs to buy foreign currency and sell RMB in the foreign exchange market so as to maintain the exchange rate relatively stable or orderly appreciated. Coupled with China’s implementation of the compulsory settlement system, it leads to a sharp increase in the scale of China’s foreign exchange reserve. Then the foreign assets in the balance sheet of monetary authority continue to expand, which results in the expansion of the monetary base. This will increase the domestic money supply through monetary multiplier, which may influence the inflation and affect the independence of monetary policy. Therefore, in order to weaken the effect of the expansion of the money supply resulting from the expansion of the foreign exchange reserves, the central bank use sterilization tools such as the issue of central bank bills and adjusting the required deposit reserve rate. The effectiveness of monetary sterilization directly affects the independence of monetary policy, and plays an important role in keeping stable price level and achieving internal and external equilibrium.This thesis firstly focuses on the impact of international capital flows on monetary policy and necessity of sterilization. Then it describes the characteristics and changes of different kinds of capital flows in recent years, and analyses the different effects on foreign exchange reserve from the point of view of stability and volatility in capital flows. It also summarizes the status of the sterilization, discussing the characteristics of sterilization tools, including their costs and defects. In the empirical research, the modified BGT model and OLS method are used to estimate the quantitative relationship between international capital flows and the money supply in China between 2000 and 2012. The sterilization coefficient reflects the effectiveness of monetary sterilization and the offset coefficient reflects the extent of capital flows on monetary policy to offset. The recursive coefficient regressing is used to estimate the dynamic process of the two coefficients. Furthermore, empirical test is used to compare the different sterilization degree between different kinds of capital flows. Finally, some suggestions on how to alleviate the pressure on foreign exchange sterilization have been put forward.Through both theoretical analysis and empirical research above, we find some conclusions as follows:1. The monetary sterilization is overall effective in China from 2000 to 2012. The sterilization coefficient is-0.944, indicating the fact that the majority of changes in money supply resulted from the international capitals have been hedged by central bank’s interventions. However, the offset effect of capital flows is also relative high, with the offset coefficient being-0.833. Therefore, the independence of monetary policy in China is skeptical. With the relaxation of capital control and interest rate liberalization in the future, the offset effect may be even larger, which may increase the difficulty of sterilization.2. The sterilization degree between different forms of capital flows is various. The capital flows with higher stability make more contribution on foreign exchange reserve; but the central bank make higher degree towards to the other kind of capital flows, the capital with higher volatility. Here are some possible reasons. Firstly, the scale of the stable capital flows is larger than the other one, which may go beyond the range that the central bank could handle. Secondly, the volatile capital flows could make a worse shock on the economic, and the central bank increase their effort on intervention during its massive inflow period. Besides, from the source of foreign assets, we find that central bank made the highest sterilization degree on Foreign Direct Investment. This phenomenon may be related to its increase in scale and much more importance in the source of the foreign assets. From the dynamic changes, FDI had only been sterilized after 2006. The sterilization degree toward to non-FDI is much higher in 2009 and 2010. We think it is because the high inflation pressure in those days.3. The issue of central bank bills and adjustment of required deposit reserve ration have been effective for a long time. However, the increasing scale and higher costs of the sterilization, as well as the defects in both tools, limits the ability of monetary sterilization in China.4. The capital outflows in 2012 alleviate the pressure on sterilization and also reduce the direct sterilization costs for the central bank. But with the massive capital inflows in 2013 again, the conflict between the increase in foreign exchange reserve and implementation of the prudent monetary policy and deleveraging policy will be more and more serious. The central bank is likely under enormous pressure of the sterilization in the future. In the short term, we should enhance the effectiveness of sterilization, such as improving the tools, exchange rate regime and foreign exchange management system. In the long run, we must improve the international balance of payment surplus, by economic restructuring and foreign trade policies.