Terms of Trade Externality, Sterilized Interventions and Optimal Chinese Monetary Policy

11 Pages Posted: 24 Aug 2018

See all articles by Tao Liu

Tao Liu

Central University of Finance and Economics (CUFE) - School of International Trade and Economics

Dong Lu

Renmin University of China

Hang Zhou

University of International Business and Economics (UIBE) - School of Banking and Finance

Date Written: August 15, 2018

Abstract

We incorporate terms-of-trade externality into a small open economy featuring an incomplete market, sterilized intervention, and capital controls as in Chang et al. (2015), and we highlight the central banks reaction to exchange rate movement. Our calibrated model using data from China shows that an optimal monetary policy is crucially dependent on the Armington elasticity between domestic and foreign goods. For a wide range of Armington elasticity values, an intermediate exchange rate regime dominates the bipolar (fixed or floating) exchange regimes in terms of welfare gains.

Keywords: Sterilization, Terms-of-Trade Externalities, Armington Elasticity, China, Capital Controls, Welfare

JEL Classification: F31, F32, F33, E58

Suggested Citation

Liu, Tao and Lu, Dong and Zhou, Hang, Terms of Trade Externality, Sterilized Interventions and Optimal Chinese Monetary Policy (August 15, 2018). Available at SSRN: https://ssrn.com/abstract=3231663 or http://dx.doi.org/10.2139/ssrn.3231663

Tao Liu

Central University of Finance and Economics (CUFE) - School of International Trade and Economics ( email )

Beijing, 100081
China

Dong Lu

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China
13522150737 (Phone)
13522150737 (Fax)

Hang Zhou (Contact Author)

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

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