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Optimal Foreign Exchange Reserves and Financial Openness Reform

【Authors】
LU Lei, LI Hongjin & SU Naifang
【WorkUnit】
LU Lei (Financial Stability Bureau, The People's Bank of China)
LI Hongjin &SU Naifang(Operations Office, The People's Bank of China)
【Abstract】

After a brief comment on the main methods of optimal reserve estimation, with a DSGE model embodied with China's characteristics, we estimate the optimal foreign exchange reserves of China. The results show that China's reserve has exceeded the optimal level for the external payments and precautious purposes since 2004 and is now converging to optimal scale recently. The comparison analysis on the optimal reserve levels, impulse function of external demand and social welfare between different reform circumstances show that, with capital liberalization, the optimal reserve level is almost always lower than the capital control conditions and economy can restore equilibrium more quickly, regardless the exchange arrangements, because of the foreign assets allocation effects and interest rate parity mechanism. The social welfare is highest under the full reform, i.e. capital liberalization and floating exchange rate and the current 3 trillion USD FX reserves still exceeds the optimal amount level, which is quite important for China's rapid progress of further comprehensive market-orientated financial reform.
 
JEL: F31,F32,E42

【KeyWords】
Optimal Foreign Exchange Reserves,Financial Openness,Financial Reform,Social Welfare