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The anatomy of a peg: lessons from China’s parallel currencies

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Listed:
  • Saleem Bahaj

    (UCL)

  • Ricardo Reis

    (London School of Economics (LSE)
    Centre for Macroeconomics (CFM))

Abstract

China’s current account transactions use an offshore international currency, the CNH, that co-exists as a parallel currency with the mainland domestic currency, the CNY. The CNH is freely used,but by restricting its exchange for CNY, the authorities can enforce capital controls. Sustaining these controls requires tight management of the money supply and liquidity to keep the exchange rate between the dual currencies pegged. After describing how the central bank implements this system, we find a rare instance of identified, exogenous, transitory increases in the supply of money and estimate by how much they depreciate the exchange rate. Theory and evidence show that elastically supplying money in response to demand shocks can maintain a currency peg. Liquidity policies complement these monetary interventions to deal with the pressure on the peg from financial innovation. Finally, deviations from the CNH/CNY peg act as a pressure valve to manage the exchange rate between the yuan and the US dollar.

Suggested Citation

  • Saleem Bahaj & Ricardo Reis, 2024. "The anatomy of a peg: lessons from China’s parallel currencies," Discussion Papers 2401, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2401
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    References listed on IDEAS

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    More about this item

    Keywords

    Chinese monetary policy; Gresham’s law; Goodhart’s law; Money markets; RMB;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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