The Effective Exchange Rate Of Renminbi And The Monetary Policy In Open Economy

In the open economy,the monetary policy is influenced by multiple factors,in which the exchange rate contacting domestic and foreign economy is a key variable. The fluctuation of exchange rate affects the currency substitution,the international trade,the capital flows and etc;and as a result both the domestic demand and supply of money will be changed.Hence,exchange rate is also a determinant of the validity of monetary policy in open economy.Based on the foundation of macroeconomic theory in open economy and the existing research,the effect of RMB effective exchange rate is analyzed in this dissertation,using the co-integration test of non-stationary time series,vector auto-regression model,the error correction model and so on.Two influencing approaches are brought forward,and are also validated by empirical research through both the demand and supply of money.The research is to improve the efficiency of China's monetary policy in open economy.Chapter 1 is the introduction of the research background,the overview of the relevant literature,and the ideas and research methods of this dissertation.Alone with China's economy becoming more and more open,it is necessary to analyze the effect of the volatility of exchange rate on the monetary policy.The research route is given after the overview of a great deal of relevant literature.The empirical research methods include co-integration test,causality test,variance decomposition,the error correction model of non-stationary time series etc.Particularly the co-integration test methods are systematically summarized,including two-step test of Engel-Granger, Johansen test and Pesaran's bound testing approach.Through the international comparison,the RMB exchange rate index calculation method is constructed,and its historical trend is analyzed in chapter 2.As multiple countries are involved in the global economy and trade,the effective exchange rate can measure the whole comprehensive power of the currency better than bilateral exchange rate.Through the compare of the difference in seven aspects about the scope of the sample countries,weight structure of the competitive strength,trade flow and so on,the calculation methods of the major international financial institutions to the effective exchange rate is introduced.This gives a useful hint to establish a scientific and feasible model of the RMB effective exchange index.Finally the trend of RMB effective exchange rate is analyzed in four historical stages. On the basis of the evolution of macroeconomic model,the characters of China's monetary policy in open economy are discussed,and the approaches through which the exchange rate affected the monetary policy are summarized in theory in chapter 3. It is emphasized that exchange rate has become an important channel in the transmission mechanism of the monetary policy.A framework of optimal monetary policy rule proves that central bank has to take exchange rate into consideration when constructing the optimal monetary policy rules.According to the types of external impulse,we suggest two concrete approaches through which exchange rate affects monetary policy,"capital market approach "and "international trade approach".And the two approaches are further analyzed theoretically in a framework of Mundell-Fleming model.Testing how much RMB exchange rate movements and its volatility affect the currency substitution of RMB,the existence of "capital market approach" is verified in chapter 4.Model analysis shows that currency substitution level is determined by the difference in the real return rate of the two currencies and foreign exchange risk level,and that the existence of currency substitution exacerbates the exchange rate instability.Since 2003 there has been the phenomenon of "reverse currency substitution" of RMB.In empirical study,variance decomposition explains that in general the effective exchange rate influences the currency substitution to some extent, and the nominal exchange rate contributes more.Johansen test finds that there is only one long-term stable co-integration relationship.Vector error correction model reveals the short-term fluctuation of the effective exchange rate adjusts the long-run equilibrium reversely,but the extent of adjustment is limited.Therefore the phenomenon of "reverse currency substitution" is mainly due to the reality and expectation of RMB continuous appreciation,and the money supply increasing is the result of capital input for risk aversion in 10ng-term,instead of short-term arbitrage. The suggestions are as following:in the process of monetary policy formulation and implement,it is necessary for it to cooperate with exchange rate policy,and the effectiveness of monetary policy will be enhanced if nominal effective exchange rate can be taken into consideration.The influence of effective exchange rate on foreign exchange reserves and international trade is verified in chapter 5,and hence the existence of "international trade approaches" is confirmed.Taking the date of the exchange rate system reform as the base period,RMB effective exchange rate is measured firstly.Through Johansen test between effective exchange rate and trade surplus,it is shown that the depreciation of the RMB is one of the reasons leading to China's trade surplus in long run.Granger causality test finds that the change of the trade structure plays a leading role to RMB exchange rate,so only RMB appreciation cannot change our trade surplus.Empirical analysis also shows that the increase of the exchange rate elasticity will release the pressure on Chinese foreign exchange reserve increasing.In a point of view of effective exchange rate,the surface conflict between RMB appreciation and trade surplus is explained.And a thoroughly discussion is given about how foreign exchange reserves weakens the effectiveness of monetary policy in the end.The money demand function in open economy is reconstructed and tested in chapter 6,and the influence of effective exchange rate is further analyzed through the aspect of money demand.By considering some open economic factors such as RMB exchange rate,foreign interest rates etc,and by using bound test approach in this chapter,the result verifies the existence of the long-term equilibrium relationship among our narrow,broad money balances and various influencing factors.After that we obtain a long-term money demand function.The estimation results show negative correlation between the real effective exchange rate and both of narrow and broad monetary demand,but the elasticity of domestic interest rates is positive.The error correction model brings forth short-term monetary demand function,which shows the negative impulse of exchange rate to broad and narrow money balances is also significant.CUSUM and CUSUMSQ tests compare the stability of broad and narrow money demand function,finding the broad money is a better intermediary variable than narrow money in monetary policy.Chapter 7 summarizes this dissertation and looks out for further research.