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The implications of liquidity expansion in China for the US dollar

Kang, W, Ratti, R and Vespignani, JL 2016 , The implications of liquidity expansion in China for the US dollar.

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The value of the US dollar is of major importance to the world economy. Global liquidity has
grown sharply in recent years with growing importance of China’s money supply to global
liquidity. We develop out-of-sample forecasts of the US dollar exchange rate value using US
and non-US global data on price level, output, interest rates, and liquidity on the US, China
and non-US/non-China liquidity. Monetary model forecasts significantly outperform a
random walk forecast in terms of MSFE in the long run. A monetary model/ECM with sticky
prices performs best. Rolling sample analysis indicates changes over time in the influence of
variables in forecasting the US dollar. China’s liquidity has a distinct, significant and
changing influence on the US dollar exchange rate. Increases in the growth rate in the relative
US-China M2 forecast a significantly higher value for the US dollar 1- and 6-month later.

Item Type: Report (Discussion Paper)
Authors/Creators:Kang, W and Ratti, R and Vespignani, JL
Keywords: China's liquidity, trade-weighted US dollar, forecasting US dollar exchange rate
Publisher: University of Tasmania
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