Sterilized Intervention, Bank Credit, and Chinese Monetary Policy

49 Pages Posted: 6 Dec 2016 Last revised: 19 Apr 2023

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 inflow surges. While existing studies suggest that sterilized foreign asset purchases by central banks can help dampen the expansionary effects of capital inflows on the domestic economy, we show that they can also have an unintended liquidity effect on domestic banks, running counter to the aims of the central banks. This is because the central bank securities issued as sterilization instruments can be used for liquidity management by commercial banks. Thus, sterilized foreign asset purchases increase the supply of liquidity management instruments. We investigate how the effectiveness of intervention can depend on the choice of sterilization instruments. The model is calibrated to the Chinese economy and used to evaluate the effectiveness of China's massive sterilized intervention in the early 2000s.

Keywords: sterilized intervention, liquidity management, bank credit, reserve requirement regulation, monetary policy, China

JEL Classification: E58, E51, F3

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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