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Effect of external shocks on domestic prices based on monetary theory.

Author(s): Li Zhou

China's foreign exchange reserve scale began to growth rapidly in resent years. At the same time, the fast growth of foreign exchange reserve also has brought some negative influences as inflation. In this paper, we use VAR model to analyze how China's excessive foreign exchange reserves effect on monetary policy. From the result, we find that the foreign exchange reserves will lead the price level sustained growth in the later several months. While once inflation happened, it will push prices continually rise, so it is much more difficult to control the inflation after it begin, so that China government should pay more attention to foreign exchange system reform, enlarge open market operations, and use sterilization or other policy instruments to reduce China's huge foreign exchange reserves.

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