An Empirical Analysis Based On The Pass-through Effect Of Exchange Rate

In traditional analysis framework, due to the law of one price, there is negative correlation relationship between a country's nominal exchange rate and relative prices and the exchange rate pass-through is complete. However, after a large number of empirical tests, emerging conflicts constantly with traditional economic theories, economists began to consider the gap between the traditional theory and the practical problems. In recent years, in china, the "double high" phenomenon about RMB appreciation and price level rising seems to be yet another challenge to traditional theory, which rises the relationship between the exchange rate and prices once again becomes a hot research issue. The "double high" phenomenon tends against the theory of purchasing power parity. Dose mean the general laws of economics inapplicability to Chinese economy or because that Chinese economic system is different from traditional theory research? Will it persist for a long term or just momently ? How the exchange rate affect price level? Dose the Pass—through Effect abate , and if abate, how about the degree of the impact of RMB exchange rate volatility to domestic prices?This paper firstly summarizes the scholar's comprehensive research including domestic and abroad. Then on the basis of the theory of purchasing power Parity and the exchange rate overshooting , we do an in-depth study about the impact of RMB exchange rate volatility to domestic prices. This paper is divided into the theoretical analysis and empirical analysis .Based on the theory of purchasing-power parity the exchange rate overshooting ,we analyse the pass—through effect of exchange rate theoretically to reveal short-term and long-term equilibrium relationship between the change of exchange rate and the price level ;Firstly we have a descriptive analysis about different stage of the RMB exchange rate volatility and our prices to find kinds of trend.Then, selecting from January 1994 to May 2010 for the sample interval and based on the principles of economics about "exchange rate - price", we constructs the VAR and VEC model, using a series of econometric methods to do an in-depth empirical analysis, such as, the impulse response function, variance decomposition, co-integration test. Empirical analysis shows that the pass—through effect of RMB exchange rate is incomplete and the effect on the CPI is greater than on the PPI . From the results of co-integration test, we can see CPI PPI and the exchange rate have a long-term equilibrium relationship, which indicates that the purchasing power parity and the law of one price does play a role to some extent, thus make the change of CPI PPI and RMB exchange rate converge to the long-run equilibrium relationship. In the error correction model , the error correction coefficient is negative and statistically significant, indicating that there is a reverse correction mechanism in economy. Finally, based on the empirical analysis ,we explain their economic significance and analyze enlightenment to our country from the Pass—through Effect of Exchange Rate.This paper uses both normative analysis and empirical analysis method. On the one hand, through the classical theory model of "exchange rate - price" ,we analyze and summarize the Pass—through Effect; On the other hand, we constructs the VAR and VEC model and take advantage of Eviews6.0 to test the degree and direction about the impact of RMB exchange rate volatility to domestic prices. Among them,when analyzing the exchange rate system reform and the price process,we use the static and dynamic analysis method,which combines the volatility of RMB exchange rate into different historical stages of price to better grasp different kinds and characteristics.The innovation of this paper lies in using specific mathematical derivation to analyze the pass—through effect of exchange rate theoretically and taking advantage of a variety of econometric methods to measure the short-term and long-term relationship between RMB exchange rate volatility and domestic prices. In particular,we chose different Cholesky decomposition orders in order to measure the robustness of regression results.