Foreign Exchange Reserve Accumulation, Domestic Stability, and Foreign Exchange Policy: The Case of China (2001-2010)

Since reform of the foreign exchange management system in 1994, China’s foreign trade has been expanding at a fantastic pace. The resulting trade surplus has surpassed that of nearly any other economy and at the same time brought along increasing international pressure and criticism to revalue the Chinese currency. While much of the existing literature has focused on questions such as whether or not the RMB should be revalued and how its appreciation will improve the imbalance of the global economy, limited attention has been paid to the impact of (a) the changes in the RMB exchange rate and (b) the accumulation of foreign exchange reserve on the domestic economy of China – and ultimately the resulting economic growth of China. This study aims to fill this gap in the literature by studying the relationships among the exchange rate, foreign exchange reserve, and general price level of China, and draws feasible recommendations on China's future exchange rate policy.