A Study on the Impact of the Fed's Quantitative Easing Policy on the RMB Exchange Rate

Abstract

In the context of global economic integration, the United States, as a major world economic power, the adjustment and change of its monetary policy is of great significance to the fluctuation of the RMB exchange rate. By studying the characteristics of the Fed's QE (quantitative easing) monetary policy, this paper analyses its impact on international capital flows and trade markets, and describes how these impacts are transmitted to China's currency market, causing fluctuations in the RMB exchange rate.

Full text

International Journal of Global Economics and Management
ISSN: 3005-9690 (Print), ISSN: 3005-8090 (Online) | Volume 3, Number 3, Year 2024
DOI: https://doi.org/10.62051/ijgem.v3n3.02
Journal homepage: https://wepub.org/index.php/IJGEM/index
Content from this work may be used under the terms of CC BY-NC 4.0 licence (https://creativecommons.org/licenses/by-nc/4.0/).
Published by Warwick Evans Publishing.
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Warwick
Evans
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A Study on the Impact of the Fed's Quantitative Easing Policy
on the RMB Exchange Rate
Yulin Huang *
School of International Education, Hunan International Economics University, Changsha, Hunan
410205, China
*Corresponding Author: 19176687445@163.com
ABSTRACT
In the context of global economic integration, the United States, as a major world economic power,
the adjustment and change of its monetary policy is of great significance to the fluctuation of the
RMB exchange rate. By studying the characteristics of the Fed's QE (quantitative easing) monetary
policy, this paper analyses its impact on international capital flows and trade markets, and describes
how these impacts are transmitted to China's currency market, causing fluctuations in the RMB
exchange rate.
KEYWORDS
Federal Reserve; Quantitative easing (QE); RMB exchange rate; Purchasing power parity (PPP);
Capital flows
1. INTRODUCTION
After entering the twenty-first century, the international financial market has shown an unstable
situation, which has successively produced the financial and economic crisis, the COVID-19
epidemic and other events affecting the global economy. Against this backdrop, the Federal Reserve
has implemented quantitative easing on several occasions in response to the negative impact these
events have had on the US. As the world's largest economy, the adjustment and implementation of
U.S. monetary policy not only affects its own economic growth and inflation levels, but also has a
far-reaching impact on China's economy through the transmission of the international economic and
financial markets [1].
Some scholars on the Fed's QE policy on China's economic impact of in-depth study, the study found
that the Fed's QE policy on China's macroeconomic impact is concentrated in the exchange rate of
the RMB, so that China's holdings of forex accounted for by the depreciation of U.S. bonds, the
pressure of the RMB appreciation is huge, thus reducing China's trade and exports, so that China's
economy has been struck by a certain degree of blow [2]. (Feng Xiaochu, 2014)
In terms of PPP, Miao Lu (2010) argues that the US-China PPP better explains the long-term stable
equilibrium relationship between the RMB exchange rate and the US-China CPI. Therefore, the US-
China PPP can be used as a reference and evaluation of the RMB exchange rate, but the determinants
of the exchange rate do not only depend on the PPP theory [3].
In terms of capital flows, Zheng Jiandong (2020) argues that when the U.S. implements expansionary
monetary policy, the widening of the U.S.-China interest rate spread can promote cross-border capital
inflows into China, which in turn leads to the movement of the U.S.-China interest rate spread, which

13
has a long-run effect on China's cross-border capital flows, and that there is no sign of such an effect
weakening [4].
In terms of import and export trade, Li Zilei and Zhang Yun (2013) argue that the Fed's long-term
QE policy will cause China's price level to rise by increasing international commodity prices [5]. Mo
Jie (2023) shows that the direct impact of the U.S. quantitative easing monetary policy on U.S.-China
trade is smaller than the indirect impact. The appreciation of RMB will have a negative effect on
China's exports and a positive effect on imports [6].
In terms of policy recommendations, Zhang Ming (2008) argues that under the impetus of trade
surpluses, interest rate differentials and capital inflows caused by the Fed's QE policy, the RMB is
under tremendous pressure to appreciate against the U.S. dollar, and in order to curb the further
appreciation of the RMB against the U.S. dollar, China's central bank has to resort to weakening the
independence of its monetary policy or strengthening its control over capital inflows [7].
From the point of view of existing research, scholars analyzed the impact of QE monetary policy on
China's economy through the purchasing power parity, international capital flows and import and
export trade at three levels, deeply analyzed how the Fed's QE policy through a variety of ways to
influence the dynamics of the exchange rate of the RMB, and put forward a number of policy
recommendations and coping strategies for weakening the impact of the Fed's QE policy. These
research results have laid a theoretical foundation for the research of this paper, which provides
certain guidance and reference for the research based on the above research.
2. OVERVIEW OF THE FED'S QE POLICY
Quantitative easing, as an unconventional monetary policy, is usually complemented by interest rate
cuts. After implementing a policy of zero and near-zero interest rates, the central bank injects a large
amount of liquid funds into the market through a series of interventions, such as purchasing assets,
repurchasing medium- and long-term bonds, such as treasury bills, and increasing the supply of base
money [8], in order to encourage spending and borrowing, that is, by printing more cash (U.S. dollar
overissuance).
2.1. Time Course of Quantitative Easing by the Federal Reserve
The Fed's interest rate cut - quantitative easing cycle is mainly focused on the economic and financial
crisis and the COVID-19 epidemic period, is the Federal Reserve in order to enhance the vitality of
the country's economy, to reverse the economic decline of the strategy implemented. The specific
implementation phase is November 2008 - October 2014, March 2020 - March 2022, including QE1,
QE2, QE3, QE3+ and QE2020.

14
Table 1. Overview of the Fed's successive QE policies
Event
Time Period
Reason
Initiatives
QE1
November 2008-
April 2010
Sub-prime
Mortgage Crisis
The Fed purchased $1.25 trillion in MBS, $175
billion in agency bonds and $300 billion in
medium- and long-term U.S. Treasuries for a
total of $1.725 trillion.
QE2
November 2010-
June 2011
Debt Crisis in
Greece
The Fed purchased $600 billion in medium-
and long-term U.S. Treasuries.
QE3
September 2012-
October 2014
Escalation of The
Debt Crisis in
Europe
The Fed is purchasing $40 billion a month in
MBS and continues its OT of selling short-term
Treasuries and buying medium- and long-term
Treasuries.
QE3+
December 2012-
October 2014
U.S. Fiscal Cliff
Issues
The Fed is replacing OT with an additional $45
billion of Treasury purchases per month on top
of QE3, bringing the amount of monthly easing
to $85 billion.
Event
Time Period
Reason
Initiatives
QE2020
March 2020 -
March 2022
COVID-19
Epidemic
The Fed purchased an unlimited number of
medium- and long-term U.S. Treasuries and
MBS, expanding the amount of easing to an
unlimited amount.
QT2022
March 2022 -
The Fed began raising interest rates, signaling
the end of QE2020.
Data Source: Federal Reserve Website
2.2. The Fed's Quantitative Easing Implementation Cycle
The Fed's QE policy usually loosens the monetary base in two ways, i.e., by changing the price of
money (lowering interest rates) or by changing the quantity of money (printing more U.S. currency).
Its policy implementation cycle is roughly divided into four stages: zero interest rate policy,
supplementary liquidity, direct release of liquidity, and guiding market long-term interest rates down.
Take QE1 as an example. Starting from August 2007, the Federal Reserve made 10 consecutive
interest rate cuts, and the U.S. federal funds rate (mainly the overnight lending rate) dropped to the
ultra-low interest rate range of 0%-0.25%. In 2007-2008, the Federal Reserve acquired a large number
of non-performing assets and launched a series of credit instruments to inject a large amount of money
(supplemental liquidity) into commercial banks and non-bank financial institutions, preventing
serious liquidity shortages in domestic and foreign financial markets. In 2008 - 2009, the Federal
Reserve acquired a large number of MBS issued by Fannie Mae, Freddie Mac, and the Federal Home
Loan Bank. At this stage, the Federal Reserve directly injected capital for troubled enterprises, acting
as an intermediary to actively release liquidity to the market. 2009, with the stabilization of the U.S.
economy and financial markets, the Federal Reserve gradually through open market operations from
commercial banks and other financial institutions to purchase long-term treasury bonds, in an attempt
to guide the market to reduce long-term interest rates to encourage lending and investment activities,
so as to achieve the purpose of stimulating economic growth and controlling the level of inflation.

15
3. HOW THE FED'S QE POLICY AFFECTS THE RMB EXCHANGE RATE
3.1. Overall Trend in the Exchange Rate of RMB
Since quantitative easing by the Federal Reserve requires the injection of large amounts of dollars
into the market, it usually leads to a depreciation of the dollar. As the U.S. dollar depreciates, US
bonds held by other countries in their forex account will also depreciate. China, as one of the major
creditors of the United States, the implementation of the Fed's QE policy will often lead to the RMB
to face enormous appreciation pressure, and thus forced to appreciate [9].
From November 2008 - April 2010 (during QE1), when the Fed implemented quantitative easing for
the first time, the RMB to U.S. dollar exchange rate rose slightly by 0.14%. From November 2010 -
June 2011 (during QE2), the RMB rose about 3.25% against the U.S. dollar. from September 2012 -
October 2014 (during QE3 and QE3+), the RMB grew about 3.05% against the U.S. dollar. However,
with the end of QE3+, the RMB V entered another period of depreciation. It wasn't until March 2020,
when the Fed FOMC meeting announced a re-entry into the rate-cutting-quantitative easing cycle,
that the RMB ushered in an appreciation binge. By the end of QE2020 in March 2022, the RMB has
been lowered from 7.0119 to 6.3457 against the U.S. dollar, with the RMB appreciating by about
10.50%.
Figure 1. Annual average exchange rate of the RMB against the US dollar
Data Source: China Currency Network; People's Bank of China official website
Beyond Fed's monetary policy, the RMB exchange rate is affected by multiple factors, including the
domestic economic situation, international financial markets, and investor confidence in the RMB.
For example, in April 2012, the RMB entered a cycle of continuous depreciation due to China's
slowing economic growth and declining exports. However, with the implementation of QE3 in
September 2012, the RMB to U.S. dollar exchange rate dropped from 6.3459 to 6.3021 from
September 27, 2012 to October 18, 2012, and the RMB increased by about 0.70% in just 22 days. It
can be seen that compared with other influencing factors; the Fed's monetary policy is undoubtedly
the main reason for the fluctuation of the RMB exchange rate.
3.2. Relative Purchasing Power Parity Between China and the United States
Based on purchasing power parity theory (PPP), the market exchange rate will usually naturally
converge to the theoretical exchange rate of PPP under certain conditions, that is, the trend of the
exchange rate of the two currencies will follow the trend of the price level of the two countries [10].
This paper chooses to use CPI as a price indicator to measure the PPP between China and the United
States.
7.604
6.9451
6.831
6.7695
6.4588
6.3125
6.1932
6.1428 6.2284
6.6423 6.7518
6.6174
6.8985 6.8976
6.4515
6.7261
7.0467
6
6.2
6.4
6.6
6.8
7
7.2
7.4
7.6
7.8
8
RMB Exchange Rate

16
Table 2. Theoretical rate of change in the exchange rate of the RMB
Data Source: China Statistical Yearbook
This table calculates the CPI growth rate and the theoretical rate of change of the RPPP exchange rate
for the U.S. and China for the period 2004-2022, using the U.S. and China CPIs for 2004-2022 as the
data source (with 2000 as the base period).
Relative PPP considers the rate of change in the exchange rate to be equal to the difference between
the rates of change in the price levels (inflation) of the two countries, i.e. ∆e = ∆p - ∆p*. In 2004-
2019, the value of ∆e is basically greater than 0, which means that China's prices are rising faster than
the U.S.'s in general, and the real purchasing power of the RMB is weakening, and the RMB to U.S.
dollar exchange rate should be trending upward. However, as can be seen from the table, the RMB
was almost always in a state of appreciation from 2004-2014. The main reason for its deviation from
the RPPP theoretical exchange rate, besides China's accession to the WTO in 2001, is due to the Fed's
successive rounds of quantitative easing in 2007.
Quantitative easing, as an unconventional monetary policy conducted as a last resort when
conventional monetary policy has failed, usually triggers market concerns about the future
performance of the economy of the country where it is implemented. The four rounds of quantitative
easing implemented by the Federal Reserve from 2007-2014 led to a decline in investor confidence
in the U.S. dollar. This change in psychological expectations prompted the dollar to depreciate at a
rate that exceeded the decline in real purchasing power, forcing the RMB to bear the upward pressure
from the over-expected depreciation of the dollar. In late 2014, the RMB immediately began to rise
against the dollar following the end of the Federal Reserve's QE3+, and the RMB entered a five-year
depreciation cycle. The RMB is now in the midst of a five-year depreciation cycle, and the Fed is
now in the midst of a five-year depreciation cycle.
Similarly, in 2022, the US inflation rate is much larger than the Chinese inflation rate, and the real
purchasing power of the RMB is in an upward trend, but the value of the RMB has declined. This is
because the Fed ended QE2020 in March 2022 and sustained interest rate hikes leading to a rebound
in investor confidence in the US dollar market, which in turn influenced the movement of the RMB
to the U.S. dollar exchange rate, causing it to deviate from its relative purchasing power parity.

17
3.3. The Impact of the Fed's QE Policy on International Capital Flows
The interest rate differentials between the world's major economies and the United States are an
important factor driving international capital flows. Prior to the implementation of quantitative easing,
the Federal Reserve usually starts with a zero-interest-rate policy, which causes a large amount of
capital to flow to other economies, especially emerging markets and developing countries, in search
of opportunities for higher returns. In recent years, as China's economic growth rate is higher than
that of the United States, and the interest rates in the United States during the period of quantitative
easing were much lower than those in China, this has made more investors inclined to invest in China,
which has led to a large inflow of capital into the Chinese market [11], which has in turn contributed
to the appreciation of the RMB.
Figure 2. China's forex reserves
Data Source: China Business Yearbook
Forex reserves are the sum of foreign currencies and assets held by a country to support the value of
its currency. As can be seen from Fig. 4, China's forex reserves continued to grow from September
2007, when the United States made an emergency interest rate cut, to 2014, when the Fed's QE ended.
Generally speaking, the continuous growth of forex reserves indicates a large inflow of capital into
China. This is because capital inflows increase the demand for the RMB in the forex market, which
increases the value of the RMB and prompts the Chinese government to buy more foreign currencies
to maintain exchange rate stability.
However, if the Fed's monetary policy shifts from easing to tightening, it will begin a series of
tightening tactics such as raising interest rates and scaling back bond purchases, causing the price of
U.S. Treasuries to fall and yields to rise. Investors in pursuit of higher yields, they will choose to
transfer assets from other treasury yields lower than the U.S. treasury yields of the economy to the
US [12]. With the narrowing of the interest rate differential between China and the US, capital may
flow out of China and back to the US. This change in capital flows may have implications for China's
financial markets and economic stability [13].
3.4. The Impact of the Fed's QE Policy on China's Import and Export Trade
As the world's most important reserve currency and international trade valuation currency, the U.S.
dollar's exchange rate fluctuations will directly affect the global economic liquidity and commodity
prices. Therefore, in addition to the Fed's QE policy will lead to the appreciation of the RMB, it will
also leverage international capital flows and China's supply and demand changes in the feedback
effect of the price level, thus affecting China's import and export trade [14].
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
2007200820092010201120122013201420152016201720182019202020212022
China's forex reserves

18
Figure 3. China trade situation
Source: General Administration of Customs of China, Business Data Center of the Ministry of
Commerce of China.
The depreciation of the U.S. dollar leads to higher international commodity prices, and the cost to
Chinese firms of purchasing dollars to pay for imported goods increases, requiring them to pay a
higher value of currency for the same amount of goods. As a result, domestic enterprises and
consumers will gradually reduce their demand for imports and instead expand their demand for goods
in the domestic market. Demand in the domestic market exceeds supply, leading to a sustained rise
in domestic prices and a gradual increase in the cost of production for enterprises, which will have a
negative impact on China's trade and exports.
However, as can be seen from Fig. 3, China's total exports are increasing after the Fed restarts QE
policy in 2020. In addition to the factor of the world's high dependence on the Chinese economy [15],
this may also be due to the fact that the Fed's QE policy has led to an increase in the supply of U.S.
dollars in the market and a significant drop in the cost of capital. A large number of investors have
turned their attention from the U.S. market to the equally vast Chinese market in search of higher
rates of return. The large amount of foreign capital made it easier for Chinese exporters to access the
capital they needed to keep expanding their production scale, thus increasing Chinese trade exports.
In addition, as the trade surplus widened, the rising demand for currency further contributed to the
appreciation of the RMB.
4. HOW CHINA RESPONDS TO THE NEXT ROUND OF FED'S QE
POLICY
4.1. Forex Policy
As shown in Fig. 4, since China's economic growth has long depended on exports, the degree of
foreign trade dependence is currently still in a high state, which makes China's economy highly
correlated with its major trading partners, such as the United States and the European Union, and
foreign economic factors have a large impact on China's economy, which can easily lead to economic
fluctuations.
0
2
4
6
8
10
0
10000
20000
30000
40000
Annual average exchange rate of the RMB against the US dollar
Total exports (US$ billion)
Total imports (US$ billion)
Balance of Trade(US$ billion)

19
Figure 4. China's Degree of Dependence Upon Foreign Trade
Data source: EPSDATA
Under the Fed's QE policy, the depreciation of the U.S. dollar has put pressure on the RMB to
appreciate. China's central bank often needs to consume a large amount of forex reserves to intervene
in the forex market, buying U.S. dollars and selling RMB, in order to mitigate its impact on exporters
and keep the stability of the forex market. This may put some pressure on China's forex reserves,
which can be mitigated by the Chinese central bank by appropriately adjusting the structure of its
forex reserves, increasing the proportion of non-dollar currencies or assets in its forex reserves, and
reducing its dependence on the dollar. China can also strengthen monetary cooperation with its major
trading partners in order to jointly respond to the challenges posed by the Fed's QE policy. For
example, currency swap agreements could be signed with major trading partners to increase mutual
currency liquidity to reduce the effect of exchange rate fluctuations.
In addition, while ensuring the liquidity and security of forex reserves, China can gradually promote
reform of the forex market, increase the openness and transparency of the forex market, and enhance
the forex market's ability to self-regulate. It should be noted that this measure requires China to
implement a prudent monetary policy in order to maintain an appropriate level of money supply and
interest rates to prevent the occurrence of financial risks during the reform process.
4.2. Capital Flow Management
The large inflows and outflows of cross-border capital flows may cause serious shocks to the
economic and financial stability of emerging market countries, triggering currency crises and
financial market turmoil [16]. As the largest emerging market and developing country, China's
international capital inflows and outflows have gradually become an important factor affecting
China's economic stability as the volume of international trade and the total amount of its economy
continue to grow.
The continued growth of forex reserves during the Fed's quantitative easing period suggests large
capital inflows into China. In order to maintain exchange rate stability. China usually carries out
capital flow management, the most direct means is to raise the exchange rate floating range. The
increase of the exchange rate floating range can release the pressure of RMB appreciation, correct the
price of the RMB exchange rate, and fundamentally inhibit the inflow of international capital into
China, so as to reduce the impact of international capital flows on China's macroeconomy.
In addition, increasing foreign currency holdings is also an effective means of controlling capital
flows. The Chinese government can equalize the balance of payments and ease the pressure of RMB
appreciation by increasing the amount of outward investment and purchasing large amounts of foreign
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
China's Degree of Dependence Upon Foreign Trade

20
currencies. At the same time, the expansion of outward investment can also break up part of China's
forex reserves and reduce exchange rate risks, thus increasing the independence of monetary policy.
5. CONCLUSION
In sum, the Fed's QE policy has had a significant and complex impact on the RMB exchange rate.
During the period of quantitative easing, the significant increase in the global supply of U.S. dollars
led to a relative depreciation of the U.S. dollar, which in turn generated appreciation pressure on the
RMB exchange rate, resulting in greater exchange rate risk and market uncertainty for China's
financial markets and import and export enterprises.
To this end, China should pay close attention to the Fed's policy changes and the dynamics of the
international financial market, strengthen the research and innovation of forex policy, and take
appropriate capital flow management measures to cope with the impact of the Fed's QE policy, in
order to better adapt to the Fed's QE that may continue to occur in the future - the cycle of interest
rate cuts.
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