Chinese Stylized Sterilization： The Cost-sharing Mechanism and Financial Repression

This paper attempts to explain why sterilized intervention was so successful and sustainable in China during the first decade of the 21st century. We argue that the Chinese Government established a sterilization cost‐sharing mechanism among the People's Bank of China, commercial banks and the household sector. On the one hand, Chinese commercial banks have to assume some of the sterilization costs by purchasing low yield central bank bills and maintaining high levels of required reserves. On the other hand, Chinese households assume some of the sterilization costs by bearing negative real deposit interest rates. The cost‐sharing mechanism under financial repression prevents a huge quasi‐fiscal loss by the People's Bank of China as well as high inflation. However, Chinese households have become victims of this financial repression. Faced with the pressure of changing the growth model from investment‐driven to domestic consumption‐driven, the interest rate will have to be liberalized eventually, which will, in turn, make sterilized intervention unsustainable.