A STUDY OF THE DIVERSIFICATION OF CHINA'S FOREIGN RESERVES WITHIN A THREE-COUNTRY STOCK-FLOW CONSISTENT MODEL

The paper presents a three-country stock-flow consistent model, with one fixed exchange rate and two flexible exchange rates, in the tradition of portfolio balance models with imperfect asset substitutability. The model is applied to simulate the impact of the diversification of the foreign reserves of China, away from US dollars and towards euros. The simulation results show that China and the USA both benefit from diversification, while the Euroland economy slows down. An intriguing feature of the model is that it generates path dependence. Copyright © 2009 The Authors. Journal compilation © 2009 Blackwell Publishing Ltd.