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The anatomy of a peg: lessons from China's parallel currencies

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  • Bahaj, Saleem
  • Reis, Ricardo

Abstract

Two currencies circulate in parallel in China, the mainland CNY and the offshore CNH. This implements capital controls as long as their exchange rate is pegged. This paper characterises this peculiar system by isolating the conventional channels through which monetary and liquidity policies sustain it. Using a rare instance of exogenous transitory increases in the supply of money, we find causal evidence that they de- preciate the exchange rate and we pin down the interest elasticity of the demand for reserves. Using an instrument for changes in the demand for money, we quantita- tively decompose the success of the peg into the joint contribution of monetary and liquidity policies. Using a model of offshore exchange rates and money creation by banks, we show that a menu of policies can be used, and has been used, to smooth fluctuations of the exchange rate of the yuan with the US dollar.

Suggested Citation

  • Bahaj, Saleem & Reis, Ricardo, 2024. "The anatomy of a peg: lessons from China's parallel currencies," CEPR Discussion Papers 18749, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:18749
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    More about this item

    Keywords

    Chinese monetary policy; Money markets;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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