The Implications of Liquidity Expansion in China for the Us Dollar

34 Pages Posted: 1 Feb 2016

See all articles by Wensheng Kang

Wensheng Kang

Ronald A. Ratti

Western Sydney University - Department of Economics & Finance

Joaquin Vespignani

University of Tasmania - School of Economics and Finance; Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA)

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Date Written: 2016-01-01

Abstract

The value of the US dollar is of major importance to the world economy. Global liquidity has grown sharply in recent years with growing importance of China’s money supply to global liquidity. We develop out-of-sample forecasts of the US dollar exchange rate value using US and non-US global data on inflation, output, interest rates, and liquidity on the US, China and non-US/non-China liquidity. Monetary model forecasts significantly outperform a random walk forecast in terms of MSFE at horizons over 12 to 30 months ahead. A monetary model with sticky prices performs best. Rolling sample analysis indicates changes over time in the influence of variables in forecasting the US dollar. China’s liquidity has a distinct, significant and changing influence on the US dollar exchange rate. Post global financial crisis, increases in the growth rate in China’s M2 forecast a significantly higher value for the US dollar 12 months and 18 months ahead and significantly lower values for the US dollar 24 and 30 months.

JEL Classification: E41, E51, F31, F41

Suggested Citation

Kang, Wensheng and Ratti, Ronald A. and Vespignani, Joaquin, The Implications of Liquidity Expansion in China for the Us Dollar (2016-01-01). Globalization and Monetary Policy Institute Working Paper No. 264, Available at SSRN: https://ssrn.com/abstract=2725022 or http://dx.doi.org/10.24149/gwp264

Ronald A. Ratti

Western Sydney University - Department of Economics & Finance ( email )

Sydney, NSW 1797
Australia

Joaquin Vespignani

University of Tasmania - School of Economics and Finance ( email )

Commerce Building,
Sandy Bay Campus
Sandy Bay, TAS, Tasmania 7005
Australia

Australian National University (ANU) - Centre for Applied Macroeconomic Analysis (CAMA) ( email )

ANU College of Business and Economics
Canberra, Australian Capital Territory 0200
Australia

No contact information is available for Wensheng Kang

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