Real Exchange Rate Determination In China's Transitional Economy

These years the controversy about Renminbi exchange rate has been scorching. Our exchange rate system reformed dramatically on July 21, 2005 and from that day on the Renminbi exchange rate will be made in reference to a basket of currencies. This paper develops a simple theoretical model of exchange rate determination in a transitional economy. The distinguishing feature of the model is the retention of market failures pertaining to the production and consumption of non-tradable goods, such as the rigidity of price and wage, monopoly, the availability of reliable data and large sum of subsidy. These features really apply to China's current economic status. Then work out the real exchange rate of Renminbi by adjusted purchasing power parity and analyze the nominal exchange rate, subsidy and wage policy's effects on real exchange rate respectively. This paper will present positive methods, including qualitative analysis which will shed great light on the factors influencing real exchange rate determination in transitional economy and quantitative analysis which will make great use of table and data to describe the relationship between real exchange rate and its related factors. At last this paper will present policy proposal for the process of macroeconomic and structural adjustment.