Sterilized Intervention, Bank Credit, and Chinese Monetary Policy

50 Pages Posted: 6 Dec 2016 Last revised: 26 Apr 2025

See all articles by Wukuang Cun

Wukuang Cun

Shanghai University of Finance and Economics - Department of Finance

Jie Li

Central University of Finance and Economics (CUFE)

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

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

Wukuang Cun (Contact Author)

Shanghai University of Finance and Economics - Department of Finance ( email )

Shanghai, 200433
China

Jie Li

Central University of Finance and Economics (CUFE) ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

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