Macroeconomic impacts of China’s foreign exchange reserve accumulation: a vector autoregression analysis using pure-sign-restriction approach

ABSTRACT

This study employs pure-sign-restriction approach analysing the macroeconomic impacts of foreign reserve accumulation and discusses the foreign exchange sterilization behaviour of the People’s Bank of China (PBoC). Sign restriction analysis shows that the effects of reserve accumulation shock are initially ambiguous on all variables, but later a positive influence only on base money can be observed. With regard to sterilization intervention, the effect is significant even though it degrades gradually over time. In China, the monetary authority actively undertakes sterilization intervention in order to remove the influence of passive release of base money caused by foreign reserve accumulation.

KEYWORDS:

• Foreign exchange reserve accumulation
• sign restriction
• sterilization intervention

JEL CLASSIFICATION:

• E58
• F49
• O11

Acknowledgements

The author would thank the editor and two anonymous referees for their comments as well as Professor Eiji Ogawa, Professor Hisashi Nakamura, Professor Takau Yoneyama, Professor Masaharu Hanazaki and Professor Yokihiro Yasuda for their supervision and comments. The early version has been presented at the 2015 Autumn Annual Meeting of the Japan Society of Monetary Economics and received many valuable comments from Professor Junko Shimizu, Professor Kenji Iwata and other participants. Besides, I also like to thank Professor Philip C. MacLellan for his guidance and help in academic writing. This work was supported by the Ministry of Education Humanities & Social Science Fund under Grant No. 15YJC790086 and the China Postdoctoral Science Foundation under Grant No. 2015T80276.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ The dollar-denominated foreign exchange reserves are adjusted by the spot USD/CNY exchange rate from the Board of Governors of the Federal Reserve System to obtain the foreign reserves denominated in RMB.

² Funds outstanding for foreign exchange and base money come from the PBoC.

³ Due to the fact that China reports quarterly GDP since 2005 thus not long enough to match other six variables, added value of industrial output as the alternative of output is used to build the VAR system.

⁴ Real effective exchange rate indices come from the Bank for International Settlements (BIS).

⁵ The data of domestic credit cannot be directly obtained from the balance sheet of the PBoC, so we calculate it through summarizing the claims on government, claims on other depository corporations, claims on other financial corporations and claims on non-financial sector. All data come from the PBoC.

⁶ CPI was converted to the fixed base index beginning from January 2001.

⁷ Technically, testing stationarity relies on predetermining if there is an implied deterministic trend or not. Meanwhile, judging whether there is a deterministic trend or not needs the information of data stationarity.

⁸ In this article, we only focus on the application and meanwhile more information about the impulse vector can be found in Uhlig (2005).

⁹ In contrast to most other countries, the PBoC seeks to sterilize the effects of reserve inflows, not just on the reserve money base by, for example, government bonds or central bank bills or by using swaps, but also on the broader money supply by increasing the deposit reserve ratio. However, because of the uncontrollability of its policy effect, more frequent adjustments of deposit reserve ratio would have a negative impact on the domestic economy and financial system. Therefore, this tool is not used much anymore in many countries except China.

Additional information

Funding

This work was supported by the Ministry of Education Humanities & Social Science Fund under: [Grant Number 15YJC790086] and the China Postdoctoral Science Foundation under: [Grant Number 2015T80276].