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Vector Autoregressive Model to analyze the Impact of Foreign Exchange Reserves on Price Level

Li Zhou, Qing-yi Chen

Abstract


With the deepening of reform and opening up, China's foreign exchange reserve increased faster in recent years. However, As China use fixed exchange rate, so that the China’s central bank should issue more domestic currency to deal with the increasing amount of foreign exchange reserves.In this paper, we use the vector autoregressive model to analysis the relationship between China's foreign exchange reserve and the consumer price index. The result shows that foreign exchange reserves is the granger reason to CPI rising, foreign exchange reserves increased 1% can drive consumer price index increased 0.14 % in the next month. Based on the cholesky decomposition, the result shows that the contribution degree of foreign exchange reserves to CPI in about 25.9%, so that the raising of foreign exchange reserves will impact on inflation.

Keywords


Vector autoregressive model, foreign exchange reserves, monetary policy, inflation, variance decomposition.

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