Abstract
This paper separates the exchange rate effect of monetary sterilization from the scale effect as a rationale for a modification of the measure of sterilization rate. The Chinese episode for 2002–2012 is characterized by a robust trend both for renminbi to appreciate vis-à-vis the dollar and for net official foreign assets to grow, which relates two of four scenarios that I generally identify for possible sterilization responses to changes in the exchange rate and official net foreign assets. I find that the modified sterilization rate in China exhibits a sort of strong “hawkish bias” in which sterilization is more sensitive to the exchange rate appreciation than to its depreciation, on one hand, and to the growth of net official foreign assets than to its decline, on the other. While there is no econometric evidence for the “hawkish bias” in the long run, the significant evidence exists for the short-run asymmetry of sterilization adjustment to be biased more toward the hawkish side than dovish side.
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Notes
The official net foreign assets refer to net foreign assets held by the central bank rather than by private sectors. To simplify the symbols, this paper just uses the abbreviation NFA to denote official net foreign assets.
The expression for sm in (1) results from the cancellation of money multiplier m in both the numerator and denominator.
The zone with f < − 1 is excluded in advance because it involves a pointless case in which the NFA declining rate f is greater than 100% in magnitude.
Monetary policy is often described as being either hawkish or dovish (the former puts more emphasis on control of inflation and economic overheating than the latter). Given that a large capital inflow is often the driving force for economic overheating and inflation in the open-economy setting, the sterilization response in this context is anti-inflationary in nature. Hence, I use the term “hawkish” in this paper to describe the strong sterilization stance against the expansionary impact of NFA growth on the money supply as well as the pressure for exchange rate appreciation, and “dovish” for the opposite.
s* in this paper, and particularly in this context, is measured by its algebraic value rather than magnitude.
In response to increases in NFA, sterilized monetary change involves the central bank’s extensions of domestic credit and increases in the reserve requirement, central bank-bond issuance, and fiscal deposits with the central bank. See Wu (2015) for details.
All the three series are stationary at their levels (i.e., I(0) series) by the three unit-root tests: augmented Dicky–Fuller test, Phillips–Perron test, and Kwiatkowski–Phillips–Schmidt–Shin test.
China’s former paramount leader, Deng Xiaopeng, has a famous saying that “growth is an iron law” (Deng 1992). Another high-ranking economic adviser indicates that “Increasing employment is the top priority among macroeconomic policy goals. … The economy needs to maintain a considerable growth as it will bring new employment opportunities.” (Li 2013).
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The author would like to thank an anonymous referee and the editor-in-chief of this journal for their helpful comments and suggestions. All remaining errors are the author’s own.
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Wu, Y. Monetary sterilization response to the movements in exchange rates and official net foreign assets: a case of China. Rev Quant Finan Acc 60, 821–838 (2023). https://doi.org/10.1007/s11156-022-01113-4
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DOI: https://doi.org/10.1007/s11156-022-01113-4