Scandinavian Working Papers in Economics

Working Paper Series,
Stockholm School of Economics, China Economic Research Center

No 2009-8: CENTRAL BANK FINANCIAL STRENGTH AND THE COST OF STERILIZATION IN CHINA

Christer Ljungwall (), Yi Xiong () and Yutong Zou ()
Additional contact information
Christer Ljungwall: China Economic Research Center, Postal: Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Yi Xiong: Peking University National School of Development, China Center for Economic Research, Postal: Beijing 100871, P.R. China
Yutong Zou: Peking University National School of Development, China Center for Economic Research, Postal: Beijing 100871, P.R. China

Abstract: This paper investigates the current monetary policy regime of China’s Central Bank, the People’s Bank of China (PBoC). This is done from the specific viewpoint of PBoC financial strength and the cost of its monetary policy instruments. The result shows that PBoC is constrained by the costs of its monetary policy instruments. PBoC tend to use less costly but market-distorting instruments such as deposit interest rate cap and reserve-ratio requirements, rather than more market-oriented but more costly instruments such as central bank note issuance. These costs remain under control today, but may rise in the future as PBoC accumulates more foreign assets. This, in turn, will jeopardize the Chinese monetary authority’s capability to maintain price stability.

Keywords: Central banking; Monetary policy; China

JEL-codes: E51; E52; E58; E63; O53

30 pages, May 1, 2009

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