Empirical Research Of The Relationship Between Exchange Rate And Interest Rate

In recent years, with China's trade and capital projects "double surplus" sustained and rapid growth, massive influx of foreign funds, the accumulation of foreign exchange reserves, substantial increase in foreign exchange, the RMB has been facing tremendous pressure of appreciation. In order to maintain a stable exchange rate, the central bank have to purchase foreign exchange,which leads to excessly increase of base currency. The central bank's monetary policy's independence and effectiveness are facing severe challenges. Therefore, we have to have a more clear understanding of the relationship between the exchange rate and interest rates.Then we can use the exchange rate and interest rate tool correctly to achieve internal and external balance, and to promote the development of economy.We choose datas from July 2005 to December 2007 on behalf of the RMB nominal exchange rate against the dollar announced by the central bank and inter-bank weighted average lending interest rate to do empirical research.After the reform of China's 2005 exchange rate system,the relations between interest rates and exchange rates are strengthen, and the impact of exchange rate on interest rates is stronger than the impact of interest rates on the exchange rate, and the mutual influence is negative. The devaluation of currency leds to a decline in interest rates, and the rising of interest rates leads to the appreciation of the currency.But the impact between Exchange rates and interest rates is low,and the linkage between them is obviously inadequate. Therefore, we select Hong Kong as a successful example of the linked exchange rate system,Japan as the successful application of the exchange rate and interest rate tool to achieve economic recovery , and Chile whose conditions are similar to China.Through the development process of these countries'exchange rates and interest rates system, as well as the mechanisms of interaction between them, we can see the effective use of exchange rates and interest rates are very important in the steady development of economy.That's useful international experience.In view of the linkage issues between current exchange rate and interest rate, we should re-examine the relations of RMB exchange rate and interest rate to make RMB exchange rate more flexible and thereby to make exchange rate and interest rate more market-oriented, with a view to maintain a sustained, rapid growth and sound way to the development of economy.