Illustration For The Applicability Of Interest Rate Parity Theory In China

With the development of economic globalization, countries are increasingly opening up and closely linked in financial markets. The impact of interest rate changes on the exchange rate fluctuations is also increasing. In the full and effective financial market, the interaction among the interest rates, exchange rates and international capital flows forms a self-balancing mechanism. And the interest-rate parity model is an abstract expression in such a mechanism. With the increasing impact of capital expenditure on the supply and demand of foreign exchange, the interest-rate parity theory remedies the deficiencies of the theory of purchasing power parity that only considers the impact of the goods and services on the exchange rate. The interest-rate parity becomes the primary theory in that it can explain the international short capital flows and the volatility of the exchange rate. Although there are still certain limitations in the interest-rate parity theory, it also illustrates the determinants of exchange rate to a certain extent in the situation of the rapid flow of international capital and the characteristics of the volatility of the exchange rate in the foreign exchange market. With China's financial system gradually merging with the international practices, opening up the financial markets, increasing international trade and international investment activities, the impact of volatility of the world financial market on China's economy will be increasing. Thus there is a lot of realistic significance because the interest-rate parity theory can offer the choices of the interest rate policy and exchange rate policy.The writing of this paper is to review the history of the interest-rate parity theory, studying from Keynes'static interest-rate parity theory to Einsig's"theory of the reciprocity". Then begin to study the modern interest-rate parity theory. The modern interest-rate parity theory makes a great improvement in the development process, which also includes the amendment of the covered interest-rate parity and the uncovered interest-rate parity. In the foregoing theory this paper makes an analysis and comparison between China and Western countries about the theory's applicability. Then it finds the reasons for the RMB exchange rate deviating from the interest-rate parity and derives a interest-rate parity model that suited to China's national conditions. At last it proposes relative measures in order to accelerate the process of China's interest rate parity.The purpose of writing this paper is to study the interest-rate parity theory, clarifying the intrinsic link between the interest rate and exchange rate. And it explains the relationship among the recent RMB exchange rate, the interest rate and the capital flows. Thus the monetary authorities can make use of the monetary instruments to regulate the supply and demand of foreign exchange markets and the exchange rate. So the interest-rate parity theory provides theoretical bases for the operation of macroeconomic regulation and the control of financial risks.