【Abstract】

In emerging market economies, transmission of monetary policy through the foreign exchange market is complicated by the coexistence of financial restrictions and arbitrages. Using China as an example, we show that the coexistence of exchange rate interventions, capital controls and an onshore-offshore exchange rate differential makes the long run equilibrium in the currency market nonlinear. Disturbances to this nonlinear long run equilibrium could offset the impact of monetary policy actions on domestic price stability. Omitting such nonlinearity leads to biased inference on the effectiveness of monetary policy.

【Keywords】

CNY; CNH; Monetary policy; Capital controls

【Authors】

He Qing, Senior Research Fellow of IMI, School of Finance, Renmin University of China

Iikka Korhonen, Member of IMI International Committee, and the Bank of Finland Institute for Economies in Transition

Qian Zongxin, Senior Research Fellow of IMI, School of Finance, Renmin University of China