Study On The Inflation Effect Of RMB Exchange Rate Volatility

With the major adjustment of RMB exchange rate formation mechanism in July2005, RMB exchange rate came to be appreciated and one of the main purposes of the policy is to reduce the Chinese huge trade surplus by means of the appreciation of RMB initiatively. According to traditional theory of macroeconomics, continued appreciation of RMB exchange rate can reduce the rapid growth of foreign trade volume through expenditure switching effect. However, the policy practice has proved that with the rapid appreciation of RMB, Chinese foreign trade surplus continued to be increasing; At the same time, the appreciation of the RMB has not effectively alleviate the rising domestic prices.Domestic prices continued to be rising and prices rising faster were the most obvious features of this round of price movement. So the dissertation studies on the following questions:Firstly, how can the inflation environment affect the import price of China when RMB exchange rate changes. It constructs a model of the effect of exchange rate movement on import prices by analyzing typical exporters pricing mechanism and takes a quantitative study of the influence of exchange rate change on the import price in china. The result shows that:firstly, the exchange rate pass-through is lower if the inflationary environment is lower and the exchange rate pass-through is higher if the inflationary environment is higher and the change of the exchange rate pass-through varies smoothly with the change of the inflationary environment. So the government should pay more attention to the increasing imported price level caused by the higher exchange rate pass-through in high inflation environment.Secondly, asymmetry effect of RMB exchange rate changes on inflation. This dissertation divides the exchange rate movement into four different states:slight appreciation?substantial appreciation?slight depreciation and substantial devaluation. By taking Markov-Switching vector auto-regression model, it uses endogenous inspection method to identify the four different states of the RMB exchange rate movement and analyzes the effect of exchange rate move on the price level in different states by using the impulse response analysis. The study shows that the impact of exchange rate move on the domestic price level in different state is asymmetry:Firstly, RMB devaluation will positively affect the domestic price and the greater magnitude of the move, the greater exchange rate movement effect; Secondly, a slight appreciation of RMB will not curb the rising price; Finally, substantial RMB appreciation will dampen the rising price in the short run while it will further drive up prices in the long run.Thirdly, the "time-varying" transmission effect of RMB exchange rate on CPI. This dissertation empirically analyzes the relationship between exchange rate and inflation movement from the mean level and fluctuation level based on the VAR-GARCH (1,1)-BEKK model. The result shows that:from the average level, the change of exchange rate is Granger cause of inflation and inflation is not Granger reason for exchange rate fluctuation; From the fluctuation point of view, the exchange rate volatility has significant ARCH effect on inflation volatility and it demonstrates that the magnitude of exchange rate volatility can affect the magnitude of fluctuation price volatility, but inflation volatility level is not significant on ARCH effect of exchange rate changes; There exists significant "time varying" relationship between exchange rate and inflation rate and the change of inflation environment and imported products structure is the main reason.Finally, the dissertation constructs a DCC-MVGARCH model to analyze the dynamic correlation between China's inflation and the China's internal and external factors and the money supply is as the representative of the internal factors whiles the change of exchange rate and international crude oil is as the representative of the external factors by taking the method of comprehensive comparison. The result shows that both China's internal and external factors are the cause of the inflation of China and the growth rate of money supply is the key determinant of the inflation and external factors have little influence on the level of inflation comparatively.At the end of the dissertation, it put forward to the following questions such as the governance of China's inflation, adjusting the external imbalance and RMB exchange rate formation mechanism reform based on the study above.