The Impact Of RMB Appreciation On China's Inflation

The exchange rate is the core variable in an open economy which influences the balance of ex-economy and in-economy. Because exchange rate will eventually reflect the situation of the economic variables in varying degrees in the open economy and the fluctuation of the exchange rate will have a profound impact on the operation of the open economy at all levels from external to internal and from the macro to the micro aspects.In recently years, along with Chinese economy steadily development, foreign trade surplus and foreign exchange reserves have gone on increasing, RMB has the pressure of appreciation. In the situation of the appreciation of the RMB, China's price level rises and takes on the characters of inflation. This departs from the truth. So whether the appreciation of the RMB has restrained the inflation, and how about the effect? So to study the impact of the appreciation of the RMB on the domestic inflation mainly measured by domestic price index has important theoretical and policy significance. Based on the thinking of these issues, this paper adopts the criterion method and the demonstration method, one side, the paper impersonally introduce the exchange rate pass-through theory and the inflation effect of the appreciation of the RMB in the criterion. This includes the complete exchange rate pass-through, the incomplete exchange rate pass-through and how the appreciation of the RMB affects the domestic general price level from direct channels and indirect channels. On the other side, the paper adopts the demonstration method to study if the appreciation of the RMB has influenced China's inflation. When study the theory, the paper puts more attention on practicability in order to offer gist to our government to constitute policy and reform system. At the same time, this paper uses a qualitative analysis and quantitative analysis methods, theory of exchange rate pass-through and inflation, to realize the qualitative model: This paper uses the relevant data from January 2003 to December 2007, and adopts the Vector Auto-regression (VAR) test to investigate the impact of the appreciation of the RMB on the import price and the domestic price level measured by CPI, to estimate the extent to which countries can bear the external impact and to use monetary policy to deal with the impact of these shocks. As a result of exchange rate movements affect domestic prices directly through prices of imported consumption goods. Through prices of imported intermediate goods, exchange rate movements affect production cost of domestically produced goods (through the channel of production cost of domestically produced goods) and through prices of domestic goods priced in foreign currency to affect the domestic price, we take the two steps to examine the extent of exchange rate pass-through. Firstly, we examine how the exchange rate movements affect the import price. Then we test the impact of the changes of the import price and exchange rate on consumer price. The method includes: Unit root tests, Granger causality test, cointegration test, error correction model test, impulse response function and variance decomposition. The conclusion is that: the transmission of the nominal effective exchange rate to the import price is incomplete. The impact of Nominal effective exchange rate on domestic price is not one-to-one. The impact of the appreciation of RMB on the domestic price level is not significant in the short term and in the long run the impact is more significant than in the short term. The long-term relationship shows that 1% changes of the nominal effective exchange rate will lead to 0.49% changes of the imported goods price index, hence the exchange rate pass-through is not fully passed. In the short term, 1% appreciation of RMB will lead to import price index 0.2% lower, thus it can be said only a small part of the impact of exchange rate shocks delivered to the import price. The impulse response function of Consumer price index shows that: One standard deviation innovation of imported goods price index will lead to consumer price index increasing 0.0007, one standard deviation innovation of nominal effective exchange rate will lead to consumer price index increasing 0.0016. The variance decomposition of consumer price index shows that: In the first phase, the changes of the nominal effective exchange rate only accounts for 3% of the changes of the consumer price index and the changes of the imported goods price index only accounts for 2.29% of the changes of the consumer price index. Hence the impact of the appreciation of the RMB on the domestic price level is not significant and overall, the nominal effective exchange rate pass-through is small.