“China’s odd monetary transmission mechanisms are largely function of distortions to the Chinese economy, particularly in the Chinese commercial banking system.” John Fernald, Federal Reserve Bank of San Francisco.
Rising interest rates in the U.S. could increase capital flight pressure on China. This could force the government to increase rates domestically, and also institute tighter measures to control offshore flows to avoid depletion of the country’s foreign exchange reserves or cause adverse impacts on monetary policy. This would come at a time when there is increasing integration of China’s financial system with the rest of the world, mainly the result of capital inflows.
However, the transmission mechanism between global and domestic Chinese rates is less clear than many assume due to the confused nature of monetary policy within China. Thus, higher rates in the U.S. many not result in a significant change in Chinese outflows. This, of course, is also subject to the degree of control China exerts over capital flight.
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