China’s implicit demand for foreign reserves: neutralization and the rise in reserves

Zhuo Tan, Shenggang Yang and Hong Zhu

Journal of Economic Policy Reform, 2008, vol. 11, issue 2, 93-99

Abstract: We estimate China’s demand for foreign reserves from 1994:1 to 2007:4. Using a monetary model for China’s reserve demand, we take into account the People’s Bank of China’s systematic neutralization policy to reduce inflation. While ultimately inconsistent, this policy has led to a growth in foreign exchange reserves that seems limitless: a neutralization coefficient of 0.57 leading to a “magnification effect” on the increase in reserves of 2.3. That is, a purchase of foreign reserves leads to a contraction of domestic credit of 57% of the foreign exchange purchase, which in turn magnifies the surplus under a stable exchange rate.

Date: 2008
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DOI: 10.1080/17487870802299208

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