Foreign Exchange Interventions, Capital Controls and Monetary Policy: The Case of China

Center for Applied Economics and Policy Research (CAEPR) Working Paper No. 2015-019

41 Pages Posted: 2 Dec 2015 Last revised: 18 May 2016

See all articles by Hao Jin

Hao Jin

Wang Yanan Institute for Studies in Economics (WISE) and School of Economics, Xiamen University

Date Written: May 17, 2016

Abstract

China has maintained a closed capital account to the private sector and channeled capital flows through the public sector by foreign exchange interventions. This paper presents an open economy model that incorporates this capital account policy configuration in order to study whether foreign exchange interventions can improve welfare in the presence of capital controls, compared to an open capital account. Furthermore, I analyze how these interventions affect the optimal conduct of monetary policy. I show that foreign exchange interventions improve welfare by strategically managing the terms-of-trade. In the presence of domestic nominal rigidity, interventions increase welfare even if monetary policy is set optimally. I find optimal monetary policy stabilizes inflation, while foreign exchange interventions correct terms-of-trade externalities.

Keywords: Foreign Exchange Interventions; Capital Controls; Monetary Policy; Chinese Economy; Welfare

JEL Classification: D6; E52; F31; F38

Suggested Citation

Jin, Hao, Foreign Exchange Interventions, Capital Controls and Monetary Policy: The Case of China (May 17, 2016). Center for Applied Economics and Policy Research (CAEPR) Working Paper No. 2015-019, Available at SSRN: https://ssrn.com/abstract=2697223 or http://dx.doi.org/10.2139/ssrn.2697223

Hao Jin (Contact Author)

Wang Yanan Institute for Studies in Economics (WISE) and School of Economics, Xiamen University ( email )

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