Timing The Adjustment Of China's RMB Exchange Rate Policies

The reformation of RMB exchange rate formation mechanism in Jul.2005 marks the acceleration of marketization of China's RMB exchange rate. Substantially the target of the exchange rate policy adjusted from pegging to a single dollar to a basket of currencies, and ultimately to the floating exchange rate system. The outbreak of global risk in recent years, such as the U.S. subprime mortgage crisis and the European sovereign debt crisis, has slowed down such reform. PRC has again restarted the policy to peg on dollars. So the implementation of the RMB exchange rate market-oriented reforms will not be easy, need to deal with capital flows caused by the global risk event preferences change, It is a discretionary choice of the timing of policy adjustments that is a breakthrough i to handle the relationship between a range of issues-currency expectations and monetary policy coordination and timely control of the Reform process.The focus of the study on both theory and policy level has long been the appreciation space and the pace of formation, processing from angles such as macro equilibrium exchange rate and market mechanism. However, there is still an absence of the research on the interaction between the business cycle, global risk factors and the opportunity of exchange rate policy adjustment. This thesis explores this area from the aspect of risk premium.It is the factual fundamentals to point the time for the adjustments in the exchange rates policies that to study the fluctuation of characteristic in the risk premium of exchange rate and macroeconomic factors. The third chapter using Hamiltion and Susmel Markov-regimes-switching-ARCH model, detected the behavior of fluctuations in RMB-exchange rate risk premium from Jan.2002 to Oct. 2010 and finds there was obvious regimes-switching in fluctuations of risk premium deduced as the deviations from uncovered interest parity on the pair of RMB/US dollar. During two periods in the global financial crisis,one was from the Sep.2007-Aug.2008 and the other from Jul. to Oct.2010 of 2007, the fluctuations of risk premium was in the high-fluctuation regime. In other periods they stayed in the low-fluctuation regime. After comparing the volatility of several macroeconomic variables in the two regimes, we find that the volatilities of the monetary variables such as exchange rate, the interest rate, the price level showed significant difference in the two regimes, while those of the non-monetary variables such as the production and the consumption didn't. And both capital-control and exchange-rate-stabilization policy could reduce the volatility of RMB exchange rate risk premium.The effect of risk factors and the premium on the exchange rate expectation provides a realistic basis for the adjustment of the RMB exchange rate policy. The fourth chapter has combed macro and market factors in the processes of exchange rates expectation formation mechanism and the foreign exchange market investors take the market intervention into their expectation formation by the "learning effect", When the foreign exchange market intervention taking the same intervention strategies in a certain period, the exchange rates expected deviation will be reduced. The empirical study found that the effects of macro-factors on the exchange rate is differently on duration and intensity while the on the exchange rate there is a "period effect" existing in the effects of risk premium on exchange rate expectation. With the duration increasing, the expected deviation is greater. Using the MSVAR model, the timing of the exchange rate policy adjustment based on risk factors, the RMB exchange rate risk premium and the US dollar index is exactly the inflection point of conversion of high and low states of RMB exchange rate expected deviations.The fifth chapter is to discuss how to coordinate the interest rate and exchange rate policies in order to drag the China out from the macro-policy selection constraints of the Mundell-Fleming's "impossible triangle" while to create space for the effectiveness of monetary policy.Explore the interaction between risk and return in currency and asset markets and, and insert the currency market risk premium and the real economy (stock market) risk premium into a macro open economy model to build the optimal interest rate reaction function. So it provides a theoretical support to adjust the level of monetary policy and how to coordinate with the exchange rate policy.The central bank's rate-setting policy, if exchange rate risk premium is taken into consideration, a downward adjustment in the driving force for the optimal level of interest rates would be given. When investors are optimistic about the economy future, it is proper to increase interest rates to ease inflation and attract "hot money" inflows lowering premium in risk assets for economic recovery. And when investors worried about the economic outlook, the international capital flows into the money market to enjoy a higher exchange rate risk premium, it is the time to accelerate the pace of market-oriented reform of RMB exchange rate.In order to maintain the stability of financial markets and capital markets, it is necessary to timely observe risk factors in domestic and international economic environment and the fluctuations of the risk premium. choose the timing of the foreign exchange market intervention to maintain a stable exchange rate。The policy recommendations for timing the adjustment of China's RMB Exchange Rate Policies are as follows:the pace marketization of China's RMB exchange rates should be discretionary, especially when the international risky events frequently happened exchange rate is desirable to peg against the dollar policy; When coordinating exchange rate and monetary policies discretionally so as improved the effectiveness of monetary policy implementation, it is need to refer to the RMB exchange rate expectations and the inflection point in the exchange rate expectation and "learning effect" mentioned above. While controlling the process of exchange rate reformation, it is important to promote the marketization of interest rates, open capital account and enrich financial instruments in RMB offshore and onshore markets gradually and ultimately the long-term goal of China's exchange rate reform, to establish a more flexible RMB exchange rate formation mechanism will be realized.