The Purchasing Power Parity Theory And Its Empirical Testing In China

Before 1973 China's exchange rate system was pegged on the US dollar. However, with the collapse of the Briton Forest System in 1971 and the first petroleum crisis in 1973, the major western countries started to adopt a floating exchange rate system in March 1973. China's official exchange rate system followed suit. Beginning in late 1984 China adopted a managed floating exchange rate system, which lasted until the end of October, 1985. In July 1986, December 1989 and November 1990 official devaluations of Chinese currency happened. From April 1991 to January 1994 the managed floating exchange rate system was resumed in China. Beginning in January 1994 the official management system was blended with the market floating system, and a new managed exchange rate system came into being. Since July 21, 2005, a managed floating exchange rate system based on market demands and adjusted with reference to a package of currencies has been employed in China. Hence, the study of exchange rate systems is significant.This dissertation makes an introduction to the basic knowledge concerning exchange rates and systems, the theories about the formation of exchange rates, and the latest developments in the theories involved, particularly those in the nonlinear systems, with reference to the traditional theories in this regard.The focus is laid on purchasing power parity (PPP) tackled in the traditional theories about the formation of exchange rates and systems. Therefore, in the third part of the dissertation a further introduction is made to the theories on PPP, The dissertation proposes some ways for improvement, such as the theoretical account of the effects of transaction costs and import tariffs on PPP, the theory on the effects of salary costs on exchange rate,the extension of the PPP model based on two countries to that based on a number of countries, and the change from the static model to the dynamic one.Then,a review is conducted on the historical evolutions of these theories in six stages. The first stage is related to the literature on the early experiences of PPP. The second stage is about the hypotheses testing the random walking of the real exchange rates. The third stage has to do with a co-integration study. The fourth stage is a long-time study. The fifth stage is a panel data study. The sixth stage is a nonlinear econometric study. Next. In terms of the methods of testing, the method of bonds testing is recommended. An introduction is made to the model concerning the account for the non-feasibility of the universal PPP within a short period.The empirical focus of the dissertation is to test whether PPP exists in the formation of the exchange rate system of Renminbi yuan by means of unit root test and co-integration study, based on the monthly data from January 2001 to October 2006 (altogether 70 months). Tests are made on the exchange rates between Renminbi yuan and the US dollar as well as between Renminbi yuan and Japanese yen in two situations where the price indexes are the same and different respectively. In the situation where the price indexes are the same, the consumer price indexes are taken from both countries. In the situation where the price indexes are different, China adopted the consumer price indexes whereas the USA adopted successively the producers' price indexes (processed products) and the industrial producers' price indexes, and Japan the producers' price indexes (processed products) and the wholesale price indexes (industrial products). Conclusions are drawn as follows: (1) when Japan's price indexes are the producers' price indexes (processed products), the three-variable PPP is feasible in the exchange rates between Renminbi yuan and Japanese yen; (2) when Japan's price indexes are the wholesale price indexes (industrial products), the two-variable and three-variable PPPs are feasible in the exchange rates between Renminbi yuan and Japanese yen; (3) in other situations, any form of PPP is not feasible.The US dollar is a major currency in the world. It is found that PPP is not feasible in the exchange rates between Renminbi yuan and the US dollar, mainly because of the defects in PPP and the technical constraints present in testing it.The originality of the dissertation lies in empirical studies. The precious studies focus on whether PPP is feasible in advanced countries, whereas this dissertation mainly studies whether PPP is feasible in developing countries, based on the latest data and the differential indexes.