Research On The Effect Of Pass-through From RMB Exchange Rate Into Prices In China

The traditional international economic theory is on the basis of the law of one price, it suggests that exchange rate movements may cause the the same proportion of price changes adversely. But many theoretical and practical studies have indicated that there exist incomplete pass between the exchange rate and one country's price level. For example, in 80 years, the United States had experienced a great depreciation of the exchange rate, but the trade deficit situation had not been significantly improved. In this case, the law of one price failed. As a result, economist began to research the reason and the issue of exchange rate pass-through became hot in the field of international economics. With further research, it is found that there existing important relationship between exchange rate pass-through and monetary policy. If the exchange rate fluctuation has little impact on prices, then monetary policy can be considered more on keeping price stable and curbing inflation. For instance, since the 90s of last century, the United States, Canada and many other countries have taken monetary policy of pegging the single goal of inflation to maintain low inflation and stimulate economic growth. Therefore, the research of exchange rate pass-through become more and more important for a country to making macroeconomic and monetary policy. For China, with the reform of RMB exchange rate system in 2005, our country began to carry out the managed floating exchange rate system, which was pegged to a basket of currencies. This reform has increased the fluctuations of the RMB exchange rate and causes more influence on China's economy. Currently our country is facing greater pressure to appreciate RMB for the reason of long-term double surplus and external pressure. It appears intense controversy in domestic that whether we need to appreciate exchange rate and if RMB rises which degree it should rise to. This article come to a conclusion that we should appreciate the exchange rate slightly which is most beneficial for our country. In addition, the current economic environment china is facing is complex. Major developed countries like most countries in Europe and the United States had been taking Keynesian fiscal policies after experienced the global financial crisis in 2008, which brought about huge government debt, resulting in a debt crisis in Europe occurred in 2009. Therefore it exacerbated global economic recession. To get rid of the perishing economic situation and mitigate the huge fiscal deficits and debt, the United States adopts quantitative easing monetary policy and zero interest rate, which incurs the dollar's over issuing and depreciation. This drives the global commodity prices surging greatly and form a large pressure of imported inflation to China which make our domestic inflation situation even more severe. Whether the RMB appreciation will curb inflation and would put what impact on China's exports, how to make monetary policy to maintain price stability and complete the exchange rate target in the meanwhile. Therefore the research of exchange rate movements'impact on price level has important significance for China to confirm appropriate exchange rate and monetary policy to maintain growth of exports and economic, curb inflation.This paper deduces and makes appropriate changes on the basis of abroad classical model and adopt Johansen Co-integration test and error correction model, combined with impulse response and variance decomposition test, using the latest data from 2000 to 2010 to empirical study the exchange rate pass through on import prices and the price level. The results show that the exchange rate pass through on import prices in China has a significant negative effect, but the effect is relatively small, while the exchange rate pass through on the price level is not significant and there is a lag. Based on the findings above, we propose eligible policies and recommendations that China is appropriate to adopt a managed floating exchange rate system, moderately amplify the range of exchange rates floating, rise the exchange rate slightly. And China's current monetary policy is appropriate to adopt Taylor rule which pegs inflation. Besides we need to upgrade industrial, expand domestic demand and consumption, and reduce the proportion of investment, so that our trade and economy could continue to grow steadily.