An Empirical Investigation Of RMB Equilibrium Exchange Rate

RMB issue has become the focus of international community since late 2002. There is great international pressure to appreciate RMB exchange rate. Is RMB currency undervalued? Is the RMB exchange rate suitable since the exchange rate regime reform undertaken in 2005. Firstly, the author recalls the origin of the concept of equilibrium exchange rate and its brief history. Then he analyses the nature of short term, medium term and long term equilibrium exchange rate. He introduces the theoretical framework of the methods estimating equilibrium exchange rates as well. Moreover, he reviews the literature of RMB equilibrium exchange rate and concludes with their systematic weak points.Secondly, the author introduces some theoretical models on equilibrium exchange rates, namely, Behavioral Equilibrium Exchange Rate, Fundamental Equilibrium Exchange Rate, Natural Equilibrium Exchange Rate and Equilibrium Real Exchange Rate according to the nature of the equilibrium exchange rate, while he points out the shortcomings and applicability of each theory when used to estimate RMB equilibrium exchange rate. Based on that, the author established his own empirical model of RMB equilibrium exchange rate, with each variable explained in details.Finally, the author uses Behavioral Equilibrium Exchange Rate, BEER, approach to estimate the RMB equilibrium exchange rate from 1978 to 2007. After he gives detailed explanations of the sources and calculation of each variable, the author applies the Johansen-Juselius Co-integrating test to investigate the co-integration relation among RMB real effective exchange rate, trade surplus, real effective terms of trade, total factor productivity and foreign direct investment. The result denotes that there is only one co-integration relation among the above-mentioned variables. The author also gives the co-efficiencies of the integrating vector with the help of vector error correction techniques. Moreover, the author utilizes the impulse response functions of trade surplus, relative effective terms of trade, foreign direct investment and total factor productivity to explain the responses of RMB real effective exchange rate to the impulses of these variables. Finally, the author employs the co-integration equation to estimate current and permanent misalignment of RMB real effective exchange rate. It's interesting to note that although RMB real effective exchange rate is undervalued over long time period, with the changing of real fundamentals, the author concludes that the RMB exchange rate now is close to its equilibrium level.