Abstract
We evaluate China’s neutralization policy by monthly estimations based on the central bank balance sheet from 1999:6 to 2011:6. Our results suggest that China effectively neutralizes 66% of the change of net foreign assets under a pegged currency regime. Consequently, a purchase of one yuan of net foreign assets leads to an effective increase of 1.4 yuan in the money supply, rather than 4 yuan in the absence of neutralization. In the face of rapid growth of foreign reserves, neutralization in China is becoming increasingly difficult, consistent with Mundell’s hypothesis.
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