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Abstract
This paper examines how US monetary policy uncertainty (MPU) affects RMB deviations from covered interest parity (CIP) and how this effect is influenced by China’s capital controls, the RMB exchange rate regime, and international reserves that constrain the transmitting channel of US MPU shocks. Our findings show that US MPU has a spill-over effect and creates deviations from RMB CIP. Capital controls insulate uncertainty shocks and alleviate the US MPU spill-over effect. There are some evidence that international reserves alleviate and the liberalised RMB exchange rate regime magnifies the spill-over effect. However, their effects become insignificant in the presence of capital controls. Moreover, the US MPU effect on RMB CIP deviations becomes prominent after the 2008 global financial crisis.
Acknowledgements
We would like to thank the guest editors of the Special Issue of Economic and Political Studies on the Renminbi Internationalisation and Financial Centres for their encouragement and suggestions. All remaining errors are the authors.
Disclosure statement
No potential conflict of interest was reported by the author(s).
Notes
1 See also, for example, Borio et al. (Citation2018) and Bottazzi et al. (Citation2012).
2 Calvo, Leiderman, and Reinhart (Citation1996) find that the tightening and loosening of US monetary policy drive the boom and bust cycles of capital flows in developing countries of Latin American and Asia. Similar findings are presented in Fratzscher (Citation2012) and Forbes and Warnock (Citation2012).
3 Similar findings are in other works. For example, the shortfall of US Dollar funds increases marginal costs of global banks that fund the FX swap; this in turn affects deviations of CIP (Iida, Kimura, and Sudo Citation2018). Avdjiev et al. (Citation2019) find that the US Dollar plays a key role in risk-taking capacity in global capital markets and is associated with large deviations from CIP and with contractions of cross-border bank lending in the US Dollar.
4 Due to the availability of non-deliverable forward data, our data series starts from January 1999.
5 Baker, Bloom, and Davis construct two MPU indices using the same criteria but based on difference sets of newspapers. One index draws on hundreds of US newspapers covered by Access World News, and the other draws on a balanced panel of 10 major national and regional US newspapers. We use the index based on 10 major newspapers for two reasons: first, major newspapers are likely to devote more coverage to esoteric monetary policy matters (such as quantitative easing and forward guidance) than the broader set of small newspapers. Second, the index is more similar to another newspaper-based MPU index compiled by Husted, Rogers, and Sun (Citation2020). The MPU index differs from the BBD index with respect to scaling factors, newspaper coverage and term sets.
6 M2, trade open, and NEER are tested as I(1); therefore, we perform a first difference before entering them in a regression.
7 Summary statistics are reported in Appendix B.
8 Assuming that CIP holds initially (e.g. RMB basis = 0), a tighter capital control causes the RMB basis to negatively deviate from CIP (e.g. RMB basis becomes −0.05).