[STBI-16-03-2017] Costs and Benefits of Sterilized Foreign Exchange Intervention (i.e. Exchange Rate Protection) in China in the 2000s

Prof. James Riedel – Johns Hopkins University

11h00 on Thursday, March 16th, 2017

School of Economics – UEH

H.001 – 1A Hoàng Diệu, Ward 10, Phú Nhuận District, HCMc


From 2002 to 2010, China ran large surpluses in both the current and capital accounts of its balance of payments, which the People’s Bank of China (PBOC) purchased and held at official foreign reserves to avoid nominal appreciation of the currency. Concurrently, with its massive purchases of foreign exchange, the PBOC compelled commercial banks to buy PBOC “sterilization bonds” and raised commercial bank reserve requirement ratios to avoid monetization of its foreign exchange purchases and concomitant upward pressure on the price level (i.e. real appreciation of the currency). Sterilizing foreign exchange intervention, as China did for a decade, constitutes a violation of the implicit rules of a fixed exchange rate regime and as such can be seen as a mercantilist policy of manipulating the real exchange rate to gain, or avoid losing, international price competitiveness, what Corden (1981) termed as “exchange rate protection.” This paper sets out the simple theory of the costs and benefits of exchange rate protection and provides back-of-theenvelope estimates of their magnitude in China in the 2000s. It also explores the “other side of the story,” the decline in U.S. manufacturing employment in the 2000s, which recent literature attributes to a “China Trade Shock” that allegedly resulted from the U.S. granting Permanent Normal Trade Relations (PNTR) to China in 2001. Here it is argued that the so-called “China Trade Shock” resulted from China’s sterilized intervention policy, not the granting of PNTR. The implications of these competing hypotheses are consider in the conclusion of the paper.

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