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

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  • Zhuo Tan
  • Shenggang Yang
  • Hong Zhu

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.

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  • Zhuo Tan & Shenggang Yang & Hong Zhu, 2008. "China’s implicit demand for foreign reserves: neutralization and the rise in reserves," Journal of Economic Policy Reform, Taylor and Francis Journals, vol. 11(2), pages 93-99.
    • Handle: RePEc:taf:jecprf:v:11:y:2008:i:2:p:93-99
    DOI: 10.1080/17487870802299208
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    1. Ouyang, Alice Y. & Rajan, Ramkishen S. & Willett, Thomas D., 2010. "China as a reserve sink: The evidence from offset and sterilization coefficients," Journal of International Money and Finance, Elsevier, vol. 29(5), pages 951-972, September.
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