Essays on currency intervention, with particular reference to Chinese economy

Hailong Jin

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: While many economists suggest that a central bank should make positive profits from currency intervention to maintain price stability, profits and losses from currency intervention by the China's central bank have not received any attention in the literature. My dissertation will use three chapters to fill in this gap. Chapter 1 investigates the optimal currency intervention policy for a profitability targeting central bank using a two-period framework. It is shown that when foreign interest rate is zero, the optimal policy is nonintervention. If the interest rate is positive, a country may earn positive profits by incurring a trade surplus in the first period. However, there is an upper bound for the currency depreciation rate. A country will lose money under excessive devaluation. Chapter 2 further computes the specific annual and cumulative accounting profits and losses from 1994 when China began its currency intervention. It is shown that China's central bank initially made positive profits but since 2007 has lost a massive amount from the foreign exchange market. Chapter 3 investigates the optimal currency intervention policy for a welfare targeting government using a two period framework. It is shown that if marginal utility of income is decreasing in the exchange rate, then the optimal exchange rate are the equilibrium exchange rates that yields trade balance each period.

Date: 2013-01-01
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