Empirical Study On RMB's Equilibrium Exchange Rate From 1994 To 2004

Recently, whether the Chinese RMB was underestimated and thus needed an appreciation is a very hot topic among China and some other countries. This paper intends to make an empirical study on the RMB's exchange rate during the period from the first quarter of 1994 to the forth quarter of 2004 based on Statistics Approach, mainly on the estimation of equilibrium real exchange rate (ERER) of RMB in order to justify the effectiveness of the real exchange rate and on the assessment of the impact of appreciation on China's economy. The empirical study shows that there does exist a co integration relationship between the REER and the selected five fundamentals Gross Domestic Product (GDP), Net foreign asset (NFA), Monetary aggregates (M2), Excess Domestic Credit (EXC) and the foreign trade surplus (SURPLUS). The R squared value of the model is 0.80.We also found that during the studied period, the RMB is still in an appreciating stage. Using the estimated equation and the permanent value of the five fundamentals derived with H-P Filter method, we calculate the equilibrium real exchange rate of RMB, through which we further figure out the deviation of the REER in each term. Finally we got four important conclusions: First, the RMB's equilibrium real exchange rate is still in an appreciating stage. During the studied period, the RMB's equilibrium real exchange rate has appreciated 4.09%. Second, the deviation of REER is limited in the normal fluctuation extent (i.e., that is small than 10 percent). Third, once the deviation occurred, the REER will move back to the ERER within eight quarters. Last, the current REER of RMB is reasonable and acceptable on the fact that only a 5.34 percent higher than the ERER in the latest term (i.e., that is the forth quarter of 2004). The highlight of the paper lies in using foreign and domestic equilibrium exchange rate theories as reference to build Chinese RMB equilibrium exchange rate model. In addition, this paper adopts the latest data from 1994 to 2004.