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International monetary policy spillovers—can the RMB and the euro challenge the hegemony of the US dollar?

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Abstract

The paper scrutinizes the spillover effects of expansionary monetary policies of a center economy to the macroeconomic policies of periphery countries, dependent on the exchange rate regime. In particular, the impact of the US quantitative easing on the Chinese economy is analysed. The results suggest that the exchange rate regime plays a minor role in insulating the economies at the periphery of the world monetary system from monetary policy shocks in the center. Capital controls, on the other hand, enable the periphery countries, in particular China, to maintain a certain degree of monetary independence in the short run. In the long run, a closer Chinese–European policy coordination is argued to create a counterbalance to the predominance of the US dollar in the currently asymmetric world monetary system. This would provide an incentive to the USA to phase out undue monetary expansion.

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Notes

  1. Independent or autonomous monetary policy refers to the central bank’s ability to set interest rates according to domestic needs, e.g. with respect to the inflation rate.

  2. China is in the center of attention because of the highly politically relevant discussion regarding its current account surplus, exchange rate policy, capital controls, soaring exports and mounting foreign reserves.

  3. Carry trade is a currency speculation where investors borrow in countries with low interest rates and invest in countries with high interest rates. The interest rate differential is the investor’s profit. Additional gains are possible through exchange rate changes if the investment currency appreciates. As China’s capital controls prohibit carry trades, speculative capital entering China is, by definition, illegal. It will be referred to as hot money.

  4. The lower level of the Japanese bond yield can be explained by appreciation expectations of the Japanese yen against the US dollar (McKinnon and Goyal 2003).

  5. The high Chinese demand for US Treasuries raises the price for the bond and thus, due to the inverse relationship of bond's prices and interest rates, reduces the yields.

  6. It must be noted that the IMF (2011a) estimation is only partial and static. Although the analysis is not comprehensive, it gives a rough idea of the Chinese feedback effects on US interest rates.

  7. To explicitly quantify the feedback effects from China to the USA, it would be worthwhile to model the spillover effects, e.g. by using a New Open Economy Macro framework.

  8. With US$1.3 tn, China is the US’ major foreign holder of Treasury securities (almost US$6 tn Treasury securities are held outside the USA) (Department of the Treasury 2014).

  9. See Rüffer and Stracca (2006) for a comprehensive discussion on the definition and measurement of excess liquidity.

  10. As the underdeveloped and shallow Chinese capital market lacks profitable investment opportunities for private investors and investments in foreign assets are limited by capital controls speculative capital is likely to go into comparatively small number of Chinese assets, therefore, increasing the risk of asset price bubbles. As in Japan in the mid-1980s, Chinese property prices recently have risen significantly (Bank for International Settlements 2011).

  11. The ‘going out’ strategy refers to the promotion of outward flowing FDIs mainly by state-owned enterprises (Ma 2007; Otani et al. 2011).

  12. China is the world's main FDI recipient (World Bank data, retrieved April 2014, http://data.worldbank.org/indicator/BX.KLT.DINV.CD.WD).

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  1. Institute for Economic Policy, University of Leipzig, Grimmaische Straße 12, 04109, Leipzig, Germany

    Kristina Spantig

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Spantig, K. International monetary policy spillovers—can the RMB and the euro challenge the hegemony of the US dollar?. Asia Eur J 13, 459–478 (2015). https://doi.org/10.1007/s10308-015-0415-0

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