A Study On RMB Real Exchange Rate

As an important variable of open economy, real exchange rate can affect and explain economic growth in wide way. According to the widely held belief, the country, which is undertaking rapid economic growth, will face up real exchange rate appreciation from international experience. Since 1978's reform, RMB real exchange rate presents different moving trend at 1993 with China long-term fast economic growth. Therefore, it is very important for China to study on the issue of RMB real exchange rate. This paper contains three parts, Part I considers issues that arise in the definition and measurement of real exchange rate. Part II focuses on the sources of the fluctuations of RMB real exchange rate. Part III turns to the RMB equilibrium real exchange rate.In part I , we provide a general summary of conceptual and empirical issues relevant with defining and measuring the real exchange rate. Then we analyze the changes of RMB external and intenal real exchange rate and the shocks of its changes during 1985-2005. Based on the analysis, we draw the following conclusions:(1)The tendency of RMB external real exchange rate can basically be divided into two stagesduring the investigating period-the wide devaluation stage during 1985-1993,which mainly result from RMB nominal effective exchange rate devaluation in that period, and slight appreciation stage during 1993-2005, which is decided by RMB nominal effective exchange rate and Chinese trading partners relative price index in that period together. (2) The tendency of RMB internal real exchange rate canbasically be divided into two stages during the investigating period-the widedevaluation stage during 1985-1994, which mainly result from the increase of China's CPI as nontradable goods proxy in that period, and slight fluctuation stage during 1994-2005 which is decided by China's CPI and world unit import goods price index in that period together. (3) According to the above conclusions, we find that RMB external and internal real exchange rate move separately and the gap between them become wider and wider since 1990. In part II, we study real exchange rate fluctuation from three sources, including supply shock, demand shock and nominal shock, and carry on the empirical research on the relationship between them. Our study shows:Firstly, RMB real exchange rate and supply shock. The tendency of China's labor productivity presents different moving trend at 1993. Labor productivity of nontradable goods sector increase faster than tradable goods sector before 1993. While Labor productivity of tradable goods sector increase faster than nontradable goods sector after 1993. On the basis of further analysis, we found tradable and nontradale goods sector wage move together. Since 1994, "Balassa-Samuelson effect" has been found in China, i.e., the increase on relative labor productivity between China and U.S. is the reason of appreciation of RMB real exchange rate against US Dollar, and the increase on relative labor productivity between China and OECD is the reason of appreciation of RMB real effective exchange rate.Secondly, RMB real exchange rate and demand shock. In this part, we analyze theoretical relationship between government expends and real exchange rate. Then we carry on the empirical research on the relationship between RMB real exchange rate and government expends. Our study shows: an increase of China's government expends will lead to an appreciation of RMB real exchange rate, and an increase of the proportion which China's government expends on nontradable goods will also lead to an appreciation of RMB real exchange rate. Relatively, raise the proportion which China's government expends on nontradable goods can do more effect on RMB real exchange rate.Thirdly, RMB real exchange rate and monetary shock. Through SVAR method, we carry on the empirical research on the relationship between RMB real exchange rate and monetary supply. We find: under fixed exchange rate system, an increase of monetary supply will lead to an appreciation of RMB real exchange rate immediately, but the effect is gradually decreasing.Based on the analysis that how changes of Fundamental economy factors affect real exchange rate, we draw into the concept of "equilibrium real exchange rate" in part III. Under the frame of "equilibrium real exchange rate", we estimate equilibrium real exchange rate of RMB and misalignment of RMB. We select four variables as explaining variables of RMB real exchange rate, these variables including labor productivity, government expends, monetary supply and openness.Our study shows: (l)An increase of labor productivity will lead to an appreciation of RMB real exchange rate. An increase of government expends will lead to an appreciation of RMB real exchange rate. An increase of monetary supply will lead to a depreciation of RMB real exchange rate. An increase of openness will lead to a depreciation of RMB real exchange rate. (2)Misalignment of RMB real exchange rate in the period of 1980 to 2005 can be divided into several parts. In the period of 1980 to 1985, RMB real exchange rate is overvalued, which mainly result from RMB nominal exchange rate overvalued in that period. In the period of 1986 to 1995, RMB real exchange rate is undervalue, which mainly result from RMB nominal exchange rate depreciation in that period. The range of undervalue is smaller overtime since exchange rate regime reform in 1994. In the period of 1996 to 2003, RMB real exchange rate is overvalued. Since 2004, RMB real exchange rate has been undervalue, but the range of undervalue is small. To the situation of RMB's undervalue, we should regulate RMB real exchange rate to make it return to the equilibrium level.