Study on the Impact of the Fed's contraction on China

Abstract

After the U.S.subprime mortgage crisis in 2007, the Fed has injected a lot of liquidity into the market through three rounds of quantitative easing policies. With time going by, the Fed's balance sheet swelled dramatically, from less than 800 billion U.S.dollars in 2007 to 4.5 trillion U.S.dollars in 2014. Since then, the United States has announced that it has withdrawn from the unconventional quantitative easing policy, normalized its monetary policy, and started a cycle of raising interest rates. In October 2017, the Fed formally started to shrink the balance sheet. Compared with raising interest rates, the effect of contraction on liquidity tightening will become more apparent. Throughout the history, it can be found that the federal reserve has implemented tightening monetary policy through reducing the scale for many times. As the opposite of the quantitative easing policy, it is quite necessary to study the impact of the fed's reducing the scale under the background that the quantitative easing policy of the United States has brought significant impact on the global economy. This paper explores the impact of the Fed's contraction on China by establishing a var model. Empirical evidence shows that the Fed's contraction will indeed affect China's exchange rate and foreign exchange reserves from the perspective of money supply.