Dissertation > Economic > Fiscal, monetary > Finance, banking > China's financial,banking > Exchange rate,foreign financial relations

The Cycle and Appropriate Scale on Foreign Exchange Reserves in China

Author ZhangXiang
Tutor HeZeRong
School Southwestern University of Finance and Economics
Course Finance
Keywords Real Business Cycle HP Filter Appropriate Scale
CLC F832.6
Type Master's thesis
Year 2009
Downloads 166
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The western economic researchers began to study foreign exchange reserve (FER) a long time ago. Under Bretton Woods System fixed exchange rate was executed and US dollar dominated international monetary system. Foreign exchange reserve played an important in making up for the balance of payment and stabilizing exchange rate. The foreign exchange reserve was hold mainly as US dollar assets. The academic circle focuses on studying the suitable FER scale and worked out many theories and metric models. The theory that FER that can support three months import is the suitable scale raised by R. Triffin was acceptable comprehensively. Since 1970s along with the development of mathematical economy, many economists have been trying to set up reserve-demanding function through mathematical model to determine the suitable scale of FER. It was the first time to analyze the respective reserve-demanding functions depending on the different situations of developed and developing countries. Cost-profit analysis opened a new door for reserve-demanding metric research and also brought international reserve theory into a new stage that FER could be estimated by a comparatively precise procedure.Since Foreign exchange reform in 1994, FRE of China has increased dramatically. By the end of 2005 FER scale has reached 818.9 billion. Facing such a gigantic scale some people is happy for this but some are worried about this. Because on one hand such a large number of FER indicates our country has a high ability to make external payment, adjust the balance of payment and intervene into foreign exchange market. The large scales of FER and FDI bring such a hardly estimated value in the expectation of the speculators and the public. They are also the vital reason for our country to confront Asia finance crisis in 1998. On the other hand, according to the present foreign exchange system, how much the scale of FER indicates how much base currency is published, so the structure of base currency changes. It easily leads to structure inflation. Since the centre bank lacks enough effective measures to offset the currency published by this way, the efficiency of monetary policy decreases and the cost of macro economy adjustment increases. We could see that after the reformation of Chinese Foreign Exchange Management in 1994, the Foreign Exchange Reserves has maintained a sustained, rapid growth trend. To the end of June 2005, the Foreign Exchange Reserves broke 700 billion U.S. dollars. Until June 2008, it has even increased to 1.76 trillion U.S. dollars. In this context, it has aroused extensive concern on the scale of Foreign Exchange Reserves, also on the appreciation of the RMB.The purpose of this thesis is to select some effective and vital factors which have big influence on foreign exchange and establish a new metric model to calculate the suitable scale of FER of China.The whole thesis can be divided into eight parts:The first part is introduction and the key points of the invention.The second part is to express some definitions of the suitable scale of FER and research introduction. This part mainly introduces the definitions of international reserve, foreign exchange reserve and the suitable scale, etc in details, and brings out the practical significance of researching the suitable scale of FER.The third part is to describe the domestic and overseas researching situation. At present the main overseas research methods are ratio analysis, opportunity cost theory, currency supply determinism, multiply factors analysis. The domestic research methods are a little motley, but most of them are to establish metric model in different angels.The forth part is the analysis of general demand and supply factors which affect FER directly (through HP filter). The demand ones include import scale, marginal propensity to import, income elasticity of demand for imports, foreign obligation, FDI, foreign exchange rate, the intervention of central bank and the developing stage of economy. The supply ones include export, FDI and foreign obligation.The fifth part is to establish metric model to analyze the appropriate scale of FER, according to our country’s situation. The practical application selects such factors as explaining variables, openness degree, foreign obligation, FDI profit redemption, terms of trade, economic developing scale, the ability to obtain overseas fund and opportunity cost of holding FER, then chooses the quarter data from 1982 to 2005 as the sample, and establishes a metric model after ADF test to examine cointegrating relationship by OLS. At last HP filter is used to process all the data to find out the suitable scale of FRE.The sixth part is the main part of the thesis. We give up the traditional method to analyze the Appropriate Scale of FRE. We believe that the Appropriate Scale of FRE somehow likes the real business cycle of the national production, so we try to use HP filter to analyze the Appropriate Scale of FRE. Based on the Real Business Cycle Theory and by HP filter method, we explored the cyclical nature of the Foreign Exchange Reserves over years. With specifically analyzing the impact of Foreign Exchange Reserves, this paper did not execute on the traditional method of cointegration, however, it followed on understanding the appropriate scale of Foreign Exchange Reserves, based on Balance Of Payments, concerned on the analysis of factors within the cycle of Foreign Exchange Reserves, and designed Foreign Exchange Reserves Indicator (Foreign Reserve Indicator).The seventh part is to bring out some suggestions of FER management, and put forward the rational ways of how to use this gigantic FER. Such ways are to invest in some potentially competitive companies, support them to“go aboard”, and encourage them to set up overseas branches to be involved in international competition.The eighth part is to sum up points and look forward the future research.The thesis is mainly based on words to narrate the viewpoints and matches with some diagrams, data and simple metric models. However, because of limited knowledge, some methods and opinions still need to be discussed and studied more in the future research.

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