The central bank’s ability to maintain a fixed exchange rate over an extended period of time while providing liquidity to troubled banks and an ailing economy are the goals almost incompatible.
After a prolonged credit boom, commercial banks typically face a mounting volume of nonperforming loans. The policy to be applied is to increase liquidity, lower interest rates, and direct assistance from the central bank.
The policy of lowering interest rates and easing monetary conditions to support the exchange results to foreign investors pulling their money out of the country.
From 2003 to 2012, many central banks, including China’s, became accustomed to managing large capital inflows. They bought dollars in order to keep their currencies from appreciating.
They also increase their commercial banks’ reserve requirements to offset the expansionary effects of the accumulation.
China’s commitment to keeping the exchange rate steady appears to be incompatible with its recent turn toward more accommodative monetary policies. Efforts to sterilize capital outflows often end poorly.