Central bank financial strength and the cost of sterilization in China

Using a unique monthly data set over the period 2000:1–2008:12, this paper presents empirical findings on Chinaʹs central bank, the Peopleʹs Bank of China, from the viewpoint of its financial strength and the cost of monetary policy instruments. The results show that PBoC is constrained by the costs of its monetary policy instruments. PBoC tend to use less costly but market-distorting instruments such as the deposit interest rate cap and reserve-ratio requirements, rather than more market-oriented but more costly instruments such as central bank note issuance. These costs remain under control today, but may rise in the future as PBoC accumulates more foreign assets. This, in turn, will jeopardize the Chinese monetary authorityʹs capability to maintain price stability.