Research On The Impact Of The Reduction Of The Fed’s Balance Sheet On China’s Monetary Policy

Since the second half of 2009,The U.S.economy has begun to show signs of recovery.Nowadays,the development of U.S.economy also is mild recovery.In 2017,the Consumer Price Index(CPI)of the United States reached a 2% inflationary expectation and the monthly Unemployment Rate has steadily decreased since 2016,basically achieving full employment.For the current U.S.economy,the huge balance sheet caused by Quantitative Easing Policy is a potential risk.So,the domestic economic situation of U.S.no longer requires extreme low interest rates and abnormal balance sheets.As early as September 2014,the Federal Open Market Committee(FOMC)released Policy Normalization Principles and Plans and claimed that it was going to advanc monetary policy normalization with raising rates and shrinking the Fed’s balance sheet.Because the previous rate policy did not achieve the expected results,the Federal Reserve also strengthened the management of the balance sheet.In June 2017,the FOMC published detailed plans to shrink its balance sheet for the first time.As the market expected,the Federal Reserve announced at the FOMC meeting in September that it will start a passive and progressive downsizing program since October.After the announcement,the U.S.Dollar Index rose,gold plunged,the10-year U.S.Treasury yield rose and the three major US stock indexes lowered across the board.In the dollar-centric modern international monetary system,the changes of the Fed’s monetary policyare bound to have a huge spillover effect and will have a significant impact on the global economy.Compared with the rate policy,shrinking the balance sheet can withdraw liquidity directly from the marke,which will result that the long-term U.S.Treasury yield rises and Dollar Index strengthen.Then,which bring about the devaluation of RMB and the outflow of international capital,ultimately causing volatility in China’s financial markets.Retrospect to 2013,Bernanke,former the Federal Reserve chairman,once made a trial on the issue of downsizing balance sheet.At that time,the shrinking signal triggered a “taper tantrum” in domestic and foreign financial markets,which is that the 10-year U.S.Treasury suffered a massive sell-off and its yields up was pushed nearly 140 basis points.However,What kinds of spillover effect will downsizing the Fed’s balance sheet have on China’s money market and foreign exchange market? How China’s monetary policy deal with a series of effects caused by this round of contraction?In order to answer the above questions better,this paper comprehensively analyzes spillover effects of the Fed’s reduction of the balance sheet on China’s monetary policy from both theoretical and empirical perspectives.First of all,this article gives a general overview of the development of monetary policy in China and the United States,of which further explores its changes in scale and structure by comparing the state of the Fed’s balance sheet before and after the financial crisis.On this basis,combined with the Fed’s plan of downsizing balance sheet to determine its way,schedule and scale.Afterwards,based on the impact analysis of the Fed’s previous shrinking balance sheet,the reverse analysis based on the Quantitative Easing Policy and the deduction of the Mundell-Fehlerm model,this paper concludes that the impact of this round of reducing balance sheet on China’s money market and foreign exchange market.Based on the theoretical analysis,this paper takes the financial market data of China and the United States from 2007 to 2017 as a sample.By constructing the SVAR model between four variables that are the scale of the Federal Reserve’s balance sheet,the representative interest rate of China and the United States and the exchange rate to engage empirical research.The results prove that,first,the shock of the Fed’s balance sheet has a lasting negative effect on the Federal Funds Rate(FFR)while explaining the volatility of the FFR more strongly.This round of contraction is equivalent to an indirect increase in FFR,resulting in an similar effect to raising interest rates.Second,in the long run,the Fed’s downsizing plan will lead to the continuous rise of the exchange rate and the pressure of the devaluation of the RMB.However,the limited impact of shrinking balance sheet will not trigger a huge shock in China’s foreign exchange market.Third,the reduction of the Fed’s balance sheet will result China’s one-year deposit rate increased and exert a passive austerity pressure on China’s monetary policy.Fourthly,according to theresults of the variance decomposition,the volatility of the Fed’s balance sheet in the short term will have little effect on the Chinese financial market,but the medium and long-term impact will gradually increase.Finally,according to the above analysis,this paper propose some policy advices for our central bank in response to the reduction of the Fed’s balance sheet.One is that continues a stable and neutral monetary policy and need not to raise interest rates in the short term.Two is that China’s monetary policy should also consider gradually tightening with following the Federal Reserve in the long run.There is that improve Interest Rate Corridor mechanism and enhance the regulatory power of monetary policy.Four is that seize the window of exchange rate reform and speed up exchange rate liberalization.Five is that abandon the counter-cyclical factor,reduce the weight of the currency basket,and promote the reform of the RMB exchange rate formation mechanism.Six is that improve the opening-up level of financial openness and promote steadily capital account convertibility.