Research On The Pass-through Effect Of Movements In The RMB Exchange Rate On Consumer Prices And Its Correlation With Monetary Policy

With the in-depth development of economic globalization, the economic ties between countries are more closely. As an exchange rate between a country’s currency and another currency, exchange rate plays an important role in global trade, and also has an influence on a country’s monetary policy. After the exchange rate changes on the market, it primarily affects import prices through import channels, thereby affecting the domestic price level. This is because, in the context of globalization, enterprises need to import imported inputs for production, and imported inputs are usually affected by exchange rate fluctuations, thereby affecting the price of the final product. Law of one price initially believed that exchange rate fluctuations would pass-through to domestic prices with the same magnitude, the exchange rate pass-through is complete. However, the establishment of law of one price needs perfectly competitive market, complete information and zero transaction costs and other conditions, but this is far from the real world. A lot of practice also shows that exchange rate volatility is not completely transferred to the price, especially in the 1980s, the dollar experienced a sharp appreciation and depreciation, but US import prices has not been much affected, the trade deficit has not improved, attracting the attention of many scholars and researchers on the issue of exchange rate pass-through.For China, in July 2005 before, there was a fixed exchange rate regime pegged to the dollar, exchange rate fluctuations were small. After exchange rate regime reform, the exchange rate pegged to the basket of currencies instead, exchange rate fluctuations enhanced, the flexibility was also increasing day by day, and the impact on the national economy was significantly increasing. So, in economic life, exchange rate fluctuations are receiving more and more attention. With the accelerated process of internationalization of the RMB, the impact of the exchange rate in international trade will also be expanded and strengthened. Therefore, the study of the impact of RMB exchange rate on the price level, that exchange rate pass-through, not only could explain the intrinsic relationship between the exchange rate and the prices, while further reveals the relationship between exchange rate volatility and the national economy.The impact of exchange rate changes on the national economy have become increasingly prominent, causing widespread concern in society, also attracting the attention of research scholars. Especially in the context of globalization and the exchange rate regime reform, how do the RMB exchange rate changes affect the domestic price level? Does the exchange rate regime reform cause changes in the pass-through effect? How does the RMB appreciation and depreciation influence the domestic price level? At the policy level, in particular how do changes in monetary policy influence the exchange rate pass-through? This article will attempt to reveal these problems by studying the exchange rate pass-through effect. With the RMB exchange rate flexibility increases, fluctuations in the exchange rate continue to increase, the research of the effect of exchange rate changes on domestic price level, especially consumer prices, has important theoretical and practical significance for inflation forecasting and control, as well as the formulation and arrangements for monetary policy.Therefore, on the basis of theoretical analysis, making use of econometric models, we analyze three aspects, containing incomplete effect, asymmetric effects of the RMB exchange rate pass-through to consumer prices, monetary policy and exchange rate pass-through, getting the following conclusions:Firstly, this paper analyzes transmission mechanism of exchange rate changes into domestic consumer prices, conducting an empirical analysis from the first season of 1994 to the last season of 2013 period. The results show that, the pass-through of exchange rate changes to consumer prices is incomplete. Whether in the long-term or short-term exchange rate changes have an impact on consumer prices, but the degree is incomplete, the degree is lower. In the sample period, the RMB exchange rate pass-through effect is on the overall downward trend, and pass-through is lagging. Then there are differences in exchange rate pass-through between countries, the level in China is higher. This paper argues that this may be related to the composition of imports. In addition, when short-term fluctuations deviate from long-run equilibrium, the adjustment is higher in the United States, followed by Japan, and China is relatively lower. This may be related to the relative maturity of the U.S. market environment.Secondly, on the basis of theoretical analysis, we analyze asymmetric effects of exchange rate pass-through from two aspects:the direction and magnitude of fluctuations in exchange rate. The results show that the pass-through of the RMB exchange rate movements to consumer prices is asymmetric. On the one hand, exchange rate fluctuates in a different direction, exchange rate pass-through is asymmetric. Compared to appreciation, when exchange rate depreciates, the level of exchange rate pass-through is higher. On the other hand, when the size of exchange rate fluctuations is different, exchange rate pass-through is also asymmetric. When the size of exchange rate fluctuations is larger, the level of exchange rate pass-through is higher. In addition, the exchange rate system reform causes structural changes in the pass-through effect. The overall pass-through effect was greater after the reform than before. Then, a comparative analysis ranging China, the U.S. and Japan shows that the exchange rate pass-through to consumer prices is asymmetric, but the direction varies among the three countries. On the one hand, exchange rate fluctuates in different directions, the influence of depreciation on consumer prices is higher in both China and the United States, while Japan is the opposite. On the other hand, exchange rate fluctuates with different magnitude, the larger RMB exchange rate fluctuations, the higher the impact on consumer prices, while Japan is the opposite. Among three countries, the thresholds of exchange rate fluctuations are different, the level in Japan is higher, up to 0.0525, China is relatively lower,0.0211, indicating a relatively large degree of exchange rate volatility in Japan. Under the floating exchange rate system, when exogenous shocks occur, the exchange rate can adjust flexibly to absorb the impact, minimizing the impact of shocks. This means that China should further promote the exchange rate regime reform, expanding the floating scope timely, and improving floating flexibility to create conditions for a more flexible exchange rate regime.Thirdly, the article attempts to study the relationship between monetary policy and exchange rate pass-through. Specifically:the pass-through elasticity not considering monetary policy indicates that there is a bias in the results. The pass-through elasticity is lower than the true value, which means that monetary policy in the long run reduces the exchange rate pass-through effect. Further taking the type of monetary policy into consideration, results show that there is a big difference in the pass-through effect. Overall, the pass-through effect is higher in tightening policy environment. Then, considering differences in the pass-through elasticities including and excluding monetary policy, the U.S. and Japan is higher than China, indicating a relatively high efficiency of monetary policy in the U.S. and Japan. In contrast, there is room for China’s monetary policy, needing to further improve the efficiency of policies. For China and the United States, when the monetary policy variable is not considered, the adjustment is low, indicating that in the short-term monetary policy reduces the speed of adjustment. By contrast, Japan is the opposite. Here we also analyze the impact of monetary policy on asymmetric pass-through effects, the results show that, on one hand, monetary policy variable is not included, there is a big difference in the level of exchange rate pass-through on the basis of exchange rate direction fluctuations. In China, the U.S. and Japan, regardless of the appreciation or depreciation, the pass-through elasticities are lower than the true value when omission of the monetary policy. On the other hand, monetary policy variable is not included, there is also a big difference in the pass-through effect based on the size of exchange rate fluctuations. Overall, the objectives of monetary policy in China, the U.S. and Japan are still to reduce price volatility.