A Study On The Effects Of Pass-Through From RMB Exchange Rate To Domestic Prices

Prices and exchange rate are core economy variables in open economy, and also they are two variables that have extremely close relationship. The traditional international economic theory suggests that exchange rate fluctuations will be reflected in proportional change in the price level, above which the exchange rate transmission is complete. Increasingly, however, facts have proven that the price of a country's pass-through is often incomplete. Since the reform of the RMB exchange rate formation mechanism in July 2005, the fluctuation of the exchange rate has been an important part of the economy. With the widening of the range of the exchange rate fluctuation, it is the focus of the academic field that whether the exchange rate fluctuation affects the stability of the domestic Prices. Meanwhile, it is the key point in the formulation and implementation of the currency policies that how does the central bank handle with the exchange rate fluctuation and the prices fluctuation by implementing the currency policies.This paper does empirical study on the Pass-through effects of the exchange rate fluctuation to the Ex- factory Price Index (EPI) and the Consumer Price Index (CPI) based on the data from January2000 to December 2010. The paper adopts JJ Co-integration Test to estimate the long term relationship of exchange rate and price, and also analyses the dynamic short term inducement of exchange rate pass- through by the Impulse Response Function and Diagnose Method.The empirical study shows that there is an incomplete pass-through of the exchange rate fluctuation to domestic prices, and stable inflation environment lead to a lower transmission. Based on the empirical conclusion and the realities of our country, the thesis presents the necessities of consummating the exchange rate formation mechanism and enhancing the independency of the currency policy.