China's Capital Account Liberalization And Rmb Exchange Rate Regime Choice

Appropriate exchange rate regime has been playing an important role in internal balance and external balance for a country. The outbreak of East Asian financial crisis in 1997 was considered that it was highly related to the choice of exchange rate regime. To some extent, de facto dollar pegging (soft peg) led to the disaster; this option was proved a failure. China also faces the choice of optimal exchange rate regime. The foreign exchange system reform of 1994 set a milestone in the process of China's external reform. After this reform, official exchange rate and swap exchange rate was united, and managed floating exchange rate regime was introduced. RMB reached convertibility under current account, and China's foreign exchange system took the shape of "RMB convertible under current account and unconvertible under capital account". Prior to the East Asian financial crisis, RMB exchange rate policy was real targets approach, under this approach, the corresponding exchange rate regime is floating exchange rate. It is vindicated that the application of real targets approach is successful with the object of promoting export; the export growth contributed a lot to GDP growth rate. However, during the period of East Asian Financial Crisis, Chinese government is very responsible, committed "No devaluation" policy, the RMB exchange rate against US$ is very stable. Since 1999, the Chinese exchange rate regime was classified as single pegging in IMF report, so there is a big shift of RMB exchange rate regime, from managed floating to de facto dollar pegging. After the recovery of East Asian Economies, Chinese policymaker will have to make a decision, continue with dollar pegging or return to managed floating regime? This thesis will try to focus on this issue and try to provide the abundant theoretical and empirical base for China's choice, and put forward the policy implications.In this essay, the theory of choosing optimal exchange rate regime is analyzed, and tries to find out the direction of RMB exchange regime choice. Actually, there is no single currency regimes is right for all the countries at all times. Under the given constraints of internal and external factors, the optimal exchange rate regime depends on the object of the government. From the literature survey, capital controls are a very important constraint for choosing exchange rate regime, so, the development of capital controls is related with the choice of exchange rate regime. It is reasonable to discuss RMB exchange rate regime from Chinese current situation. China's capital account liberalization was carried out with the approach of gradualism; this approach was vindicated very successful during and after East Asian financial crisis. However, the increasing capital flights demonstrate the declining effectiveness of capital controls, further more, China's accession of WTO will push the process of capital account liberalization. Although Chinese monetary authority can control the process of capital account liberalization, in the long run, undoubtedly, RMB will become convertible under capital account; then the current dollar pegging will be not sustainable. Consequently, from the perspective of Chinese economic growth, Chinese authority will face different mix of macro economic policy; the optimal policy mix depends on government's objective function. Because of characteristics of Chinese economy, neither hard fixed exchange rate system (currency board system or currency union) nor pure floating exchange rate regime is suitable for China, as result, China will weight the middle grounds. China will must/ have to compare the cost and benefits of different exchange regime. Because the current capital controls are almost effective, the swings of exchange rate regime will only impact on export and independence of monetary policy. It is assumed that the objects of government is promotingexport and keep independence of monetary policy. The current dollar pegging is conducive to the export; however, the object of monetary policy is subject to...