Sterilized Intervention, Bank Credit, and Chinese Monetary Policy
50 Pages Posted: 6 Dec 2016 Last revised: 26 Apr 2025
Date Written: May 15, 2019
Abstract
Foreign exchange intervention is widely used in emerging market economies as a stabilization tool to address the challenges from capital inflows. While existing studies suggest that sterilized foreign asset purchases by the central bank can help contain the excessive growth of domestic credit following capital inflow surges, we show that they can also have an unintended liquidity effect on the banking system, running counter to the goal of the central bank. This is because the central bank (government) securities, issued to finance foreign asset purchases, are liquid assets that can be used for liquidity management by commercial banks, facilitating bank lending. We document that in China the liquidity premium of central bank bills, i.e., the major instrument issued to finance foreign reserve accumulation, is around 1\%. We show also that the central bank can eliminate the unintended liquidity effect by using reserve requirement for sterilization, which can make foreign exchange intervention more effective.
Keywords: sterilized intervention, safe assets, liquidity management, bank credit, monetary policy
JEL Classification: E58, E51, F3, G21
Suggested Citation: Suggested Citation
Cun, Wukuang and Li, Jie, Sterilized Intervention, Bank Credit, and Chinese Monetary Policy (May 15, 2019). USC-INET Research Paper No. 19-10(R), Available at SSRN: https://ssrn.com/abstract=2880873 or http://dx.doi.org/10.2139/ssrn.2880873
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