Research On RMB Exchange Rate Pass-through And The Inspiration To China's Monetary Policies

Traditional international economic theory suggests that the exchange rate fluctuations will be reflected, while to the same extent, on price levels. However, more and more facts indicate that the exchange rate pass-through (ERPT) to one country's price level is usually incomplete. Since the new round of exchange rate policy reform dating from July 2005, the fluctuations of exchange rate between RMB/USD become more and more frequent, while the volatility also increases. How would the change of exchange rate put an impact on import and export enterprises' product pricing and domestic overall price level, and hence influences the structure of domestic production and investment and the economic policies from government. These questions all deserve an in-depth analysis. Moreover, due to the interaction effect existing between exchange rate pass-through and monetary policy, renminbi's ERPT effect has a signficant meaning to the development of new monetary policy.In this paper, firstly we calculate the numerical value of renminbi's ERPT, based on Vector Autoregression Model and Error Correction Model respectively, in the purpose of revealing the shocks to domestic price level from fluctuations of exchange rate. On this basis, with the micro-level explaination to RMB's incomplete pass-through, we analyse the significance of a stable ERPT for the control of inflation environment and implementation of the relevant economic policies. In the second part of the paper, we contrast the change of ERPT under different monetary policies environment (including the changes of inflation environment, impact of the volume of currency issued and of the exchange rate policy) to verify the existence of interaction effects in China, which offers empirical support for the monetary policy reforms, one of whose objectives is to reduce external shocks, and to stabilize domestic price level. In addition to the corresponding policy advices, the paper also provides new viewpoints for implementation of inflation targeting policies and strengthening of renminbi-denominated settlement. The main conclusions are as follows:1. Exchange rate pass-through for China's import prices, production price and consumer prices are incomplete, while the transmission effect has a lower order. Most of them possess a lag between 6 months to 1 year. 2. Domestic monetary policy put an obvious influence on ERPT effect. In details, stable inflation environment, low volatility of the supply of currency and low fluctuations of the exchange rate lead to a lower transmission. Besides, the large-scale use of dollars as the invoicing currency in China's foreign trade is one of the important factors of RMB's incomplete ERPT.