Exchange Rate Regime And RMB Pass-through Effect

Exchange rate is one of the important indicators of macro economydevelopment, it influences one country's import and export trade, theinternational balance of payments, and allocation of resources a lot. And weusually think, exchange rate changes impact on the macro economy in two ways:first, the exchange rate affects a country's trade balance and divisions(especially the foreign trade department) by influencing the import price, it iscalled direct transmission mechanism; Second, the exchange rate affects acountry's domestic price changes and further affect the implementation ofmonetary policy, by influencing the import price level, we call it the indirecttransmission mechanism. But no matter which kind of the transfer mechanism,exchange rate changes all affect the price level first, then influence themacroeconomic, therefore the price level is the key factors. In other words,before we study the macroeconomic effects of exchange rate changes, we mustfind out how the exchange rate affects the price level, which is called exchangerate pass-through effect.The theory of exchange rate pass-through can be traced back to the law ofone price and purchasing power parity, so that many theories in the field oftraditional macroeconomics all built on the basis of complete exchange ratepass-through effect, but the reality is not the case. A lot of economicphenomenon in the1980s showed that the exchange rate pass-through effect isnot complete, which has prompted many scholars explaining the reasonsrespectively from microeconomic theory and the new open economymacroeconomics theory. Recently the research focus transferred from theanalysis of reasons on exchange rate pass-through effect is not complete to theexchange rate pass-through's influence on the macroeconomic factors(such asinflation, monetary policy, etc.), and further on a country's trade balance,exchange rate regime and monetary policy choice and so on, which provided anew analysis framework.With the globalization of the economy, especially after China became themember of WTO in November2001, international trade develops rapidly.Exchange rate as an important bridge between the trade, the study on theRMB's exchange rate pass-through effect is very necessary. In addition, withthe deepening reform of the RMB exchange rate, on July21,2005, the regime changes from a single peg to the dollar into based on market supply anddemand, reference to a basket of currencies, managed floating exchange rateregime, exchange rate formation mechanism becomes more flexible. At thesame time, the degree of marketization of RMB exchange rate has also beengradually improved, in May2007and April2012, the central bank respectivelythe inter-bank spot foreign exchange market the yuan against the dollar tradedfloating ranges changed from three over one thousand to five over one thousand,and eventually rose to one percent. Thus, the RMB exchange rate changes moreuncontrollable, and the relationship between exchange rate and price level isbecoming more and more complicated. Considering the changes of China'sexchange rate regime, along with the constant improvement of themarketization and volatility of RMB exchange rate, we should t study theexchange rate pass-through effect, and try to give recommendations on thechoice of exchange rate and monetary policy.In this paper, we use the autoregressive distributed lag model to study theexchange rate direct pass-through mechanism, indirect pass-throughmechanism and the asymmetry of the exchange rate pass-through effect, herethis paper has eight chapters. Chapter1is introduction, mainly points out thetopic background, significance, research methods and framework, especiallyemphasizes the research innovation; Chapter2is the related literature both athome and abroad, reviews and summarizes the related theory and empiricalevidence, the theoretical literature part sums up according to the time sequenceof the research angle, the empirical literature part introduces the typicalliterature on the research methods, sample data and the research conclusion, indetail; Chapter3is exchange rate pass-though theory model, studies theeconomic factors influencing the exchange rate pass-through effect, to providereliable scientific basis to the later determination of the empirical model andthe selection of economic variables; Chapter4is the construction and analysisof ARDL model, this part introduces and compares VAR model andco-integration test adopted by the studies on exchange rate pass-through effect,and then gives the detailed introduction and explanation on ARDL model;Chapter5compares the RMB's direct pass-through effect before and after theexchange rate revaluation, based on selecting the most appropriate method andcalculating China's import price index, this chapter considers the exchange rate revaluation's impact on t China's overall and divisions direct pass-througheffect, and the possible time lag effect; Chapter6compares the RMB's indirectpass-through effect before and after the exchange rate revaluation, this paperchooses two indicators CPI and PPI to describe the domestic price level;Chapter7explores the asymmetrical effect of RMB changes on the domesticprice level by setting the virtual variable method, study whether the exchangerate pass-though effect changed significantly, when the exchange rate changesin different direction and amplitude; The last chapter summarizes theconclusions and the discusses the future study direction.Based on the above theoretical and empirical research, we can get thefollowing conclusion and revelation:Firstly, the adjustment of China's external imbalances cannot overlydepend on the appreciation of RMB. In this paper, empirical research showsthat the RMB exchange rate direct pass-through effect is relatively large, so thegoal of balancing the international trade is achievable by adjusting theexchange rate. But the exchange rate indirect pass-through effect is relativelysmall, so the role of adjusting the exchange rate to balance the internationaltrade is weaken to a certain extent. The results provides the explanation for thephenomenon of along with the appreciating of RMB, trade surplus still growing.So therefore, in order to adjust the external imbalances, in addition to a modestappreciation of RMB, the government should also expanding domestic demand,upgrading industrial structure and other aspects.Secondly, the effect of only relying on the exchange rate to control inflationis limited. Along with our country's economy develops very fast, many factorssuch as international commodity price shock,global excess liquidity influencesthe macro economy a lot, which also increases the difficulty of the governanceon the inflation in China. Today the internationalization of inflation has becomeincreasingly obvious, each country strengthens the fiscal discipline, implementeffective monetary policy to actively cope with inflation at the same time, nowthe international coordination mechanism plays more important role in copingwith inflation.Thirdly, the government should establish the reasonable industrial policyto improve China's voice in the import trade. The exchange rate pass-througheffect differs a lot for different trade sections, due to various demand elasticity, product properties, and so on. It means that the policy authorities shouldcorrectly learn about the sensitive degree of the exchange rate changes ondifferent trade industry, optimize the industrial structure and growth pattern,develop our country's own brands, reduce external dependency, strengthen theautonomy of economic development, and improve the quality of economicdevelopment. This research provides the theoretical basis and empiricalsupport to set up reasonable industrial policies and tariff policy. At the sametime in terms of a single enterprise, it is also helpful to establish a reasonablepricing strategy and competition strategy, besides improving the pricing powerin the import trade.Fourthly, the authority should keep the exchange rate reforming steadily.The results show that the exchange rate has significant impact on someindustries' import price and the domestic price. It means that the RMBexchange rate reform needs stable price and macroeconomic environment.When facing all kinds of uncertainty factors at home and abroad, the authorityshould try to avoid external shocks or economic fluctuations. While deepeningthe reform of RMB exchange rate, currency authorities need to limit andmanage the hot money inflows, keep monetary policy independence, anddynamically manage the RMB exchange rate floating, to keep the exchange ratebasically stable at a reasonable and balanced level.