Managing Foreign Exchange Revenues with the Aim of Simultaneous Preservation of Production Competitiveness and Inflation Control: A Review of China's Experience

China has experienced a substantial surplus in its balance of payments since 2000. Based on Chinachr('39')s law, its central bank buys the balance of paymentschr('39') surplus. This action, along with the closed capital accounts, can lead to an increase in the bankchr('39')s foreign asset and consequently raise the monetary base and cause inflation. This paper shows that the Central Bank of China has been successful in keeping the inflation level low through sterilization of foreign assets in a transition period when a huge surplus in the balance of payments could lead to a severe increase in the monetary base. By issuing bonds and increasing the rate of bankschr('39') required reserves, the Central Bank of China has been able to manage the incoming foreign reserves and control the growth of liquidity and monetary base. As a matter of fact, this policy has been successful in restraining the rise in the value of home currency and inflation at the same time. Afterwards, during the smooth period of the monetary base growth (the 2010s), due to inflated monetary base at the end of the transition period, the balance of payments’ surplus does not lead to a sharp increase in the monetary base anymore; therefore, bond issuing policies and raising the rate of bankschr('39') required reserves are not utilized like before.