Empirical Analysis Of The Relevance Between China's Exchange Rate And Output Fluctuation

Since the reform and opening policy came into operation in 1978, China'seconomic development has made remarkable achievements. From 1978 to 2008, theannual average GDP growth rate of China was 9.89%, which was the highest of theworld in the same period. Especially for the nearest ten years, China's output growthhas achieved outstanding results: Since China's output growth rate reached 9% in2002, it has been steadily forward, the output growth rate of 2003, 2004, 2005 was10%,10.1%,10.4% respectively, making the average output growth rate of Chinareached 9.6% during the"tenth-five"period. Although affected by the worldeconomic crisis which started from the second half of 2007, China's output growthrate still showed a increasing tendency. It was 11.6% and 13.0% in the year 2006and 2007,and there was a slight decrease in 2008,which was 9.0%.According to thereport of economic performance in 2009 from National Bureau of Statistics onJanuary 21, the GDP of 2009 was 335353 billion and showed an increase of 8.7%over the previous year according to comparable prices ,but it showed a decrease of0.9 percentage points (from the China Economic Net ).The Chinese governmentauthorities is confident of China's economic growth at present, the current economicgrowth tendency is good enough to make us believe that China is going to achievebetter results in the"Eleventh Five-Year"period.Since the 1970th, since the process of the exchange rate of RMB can be roughlydivided into the following five stages, the exchange rate of RMB we are discussinghere is under the direct quotation of the nominal exchange rate: (A) From1972 to1980, the exchange rate of RMB showed a tendency of continuing appreciation,mainly affected by the oil crisis ,the rose of world price level and theimpact of a floating exchange rate system of the major Western countries. (B) Duringthe period from 1981 to 1984, China implemented the mechanism of the co-exist offixed official exchange rate and floating exchange rate, RMB gradually depreciateunder the impact of dollar. (C) Between 1985 to 1993,under the condition of thecoexistence of the official exchange rate and the fixed Internal settlement rate, Chinahas significantly adjusted the official exchange rate and the exchange rate of RMBwas greatly devaluated during the period. (D) From 1994 to July,2005,it was theperiod of the the coexistence of official exchange rate and market exchange rate,during which the exchange rate of RMB was stable. (E) From the July of 2005 tillnow, although there were small fluctuations in the exchange rate of RMB, the overalltrend was upwarding. The exchange rate changed from 8.28 to 6.83.It is relativelystable recently, has been maintained around about 6.83. Currently, there is a highpressure coming from the international society ,calling for the appreciation of RMB.So whether RMB is undervalued? What is the degree of undervaluation?Whether the RMB should appreciate? These problems were widely discussed athome and abroad. The problem of RMB exchange rate and output volatility, is notonly a hot theoretical discussion of a long period, but also the interests concernedabout by the businessmen. If RMB is significantly undervalued, why ourgovernment is still reluctant to let RMB appreciated under the condition ofsignificantly undervalued RMB, which also make the result of the internal andexternal imbalances in China's economic situation? According to the model oftraditional macroeconomic textbook, currency appreciation will have contractionaryeffects: at least in a short-term, currency appreciation will increase the prices ofdomestic goods relative to foreign goods(real exchange rate appreciation), resultingin the reduction of its exports and the substitution of imports to domestic goods, thusreducing the total demand for domestic goods. Although our government announced that China does not want to pursue excessive trade surplus, which showed that theleadership is willing to take a variety of instruments to reduce China's trade surplus,but the government authorities are worried that the RMB appreciation will have atightening effect as traditional macroeconomic theory has said ,thus leading to theslowdown of China's economic rate and the rising unemployment, which is the mainreason why our Administration Authorities is not willing to let RMB appreciate. WillCurrency appreciation generate contractionary effects while currency depreciationgenerate expansionary effect?Economic theory also indicates that the relationship between the exchange rateand economic growth should be two-way, exchange rate movements will affecteconomic growth at one hand, on the other hand, the rate of economic growth willreacts exchange rate. So is the appreciation of the RMB contractionary as thetextbook said, or expansionary as the"tight devaluation"hypothesis said?Meanwhile, China is in a period of rapid economic growth. How is this rapideconomic growth affect the real exchange rate? Currently the empirical research onthe exchange rate of RMB and output has focused on the exchange rate changes oneconomic growth, which most scholars concentrate on the real exchange ratefluctuations affecting economic growth through the trade balance effect. What is thereal relationship between exchange rate and output fluctuations, how are they relatedto each other , what extent is the relation reached to, are not clear. Therefore,investigate the correlation between RMB exchange rate and output volatility, andthen obtained the result if the change of exchange rate volatility would affect outputor output volatility, will output or output volatility affect the exchange rate? Therewill show a very important practical significance, which will also provide areference for future changes in China's exchange rate.This article aims to analyze the relationship between RMB exchange rate andthe fluctuation of output. The extensive literature available which study the relationship between the exchange rate and output now, are mostly through theanalysis of exchange rate changes on output through the indirect impact mechanismwhile the empirical research literature which study the reaction of output toexchange rate is little.and the existing literature focus on the research of therelationship between the exchange rate and the output volatility. In this paper, we setup empirical models to study the relationship between exchange rate and outputvolatility.This paper primarily use a method which is a combining of theoretical andempirical analysis to explain the correlation between output fluctuations andexchange rate. After a summary and analysis of previous theoretical and empiricalresearch on output and exchange rate, this paper use the real exchange rate ofRMB against the U.S.dollar on behalf of the exchange rate of RMB, use the dataobtained through the establishment of EGARCH model on behalf of output volatility,mainly through the Granger causality test, VAR model, impulse response andvariance decomposition method to study the correlation between the exchange rateof RMB and output volatility. This paper is divided into four parts, the specificstructure and content are as follows:The first part summarizes the main indicators to study the experience of thefacts. First, there is an overview of RMB exchange rate and the output changes from1995 to 2008 RMB. Then raise the problem whether the appreciation of the RMBwill cause the instability of output in China and how are the exchange rate of RMBand output volatility associated with each other.The second part is the introduction of the theory at home and abroad on therelationship between and the review of the progress of empirical research onexchange rate and output volatility.The third part is the Econometric Analysis of the relationship between exchangerate and output volatility. There are some difference from the previous literature, this paper use the ratio of RMB to the US dollar to represent the exchange rate of RMB,and get the real exchange rate value through the adjustment of price ,while theprevious literature mostly study the affection of RMB real effective exchange rateeffects on output, and this paper use EGARCH model to calculate the value of outputvolatility. Then establish VAR model to study their dynamic association betweenthem, contrary to the earlier literature which apply the output change rate tosubstitute the fluctuations. And this paper apply monthly industry added value onbehalf of output value. After the collection of the monthly data between March 1995to February 2009,we select some appropriate intermediate variables, such as theInterest rate differential between China and United States, China's inflation rate andChina's money supply (M2 ) to study the model and get the association relationshipbetween the exchange rate and output volatility.The fourth part is the extension study of the association relationship betweenexchange rate and output volatility, because since the July of 2005,the exchange rateof RMB has continued to face upward pressure, so we further explore the associationrelationship between exchange rate and output volatility since July 21st, 2005 ,whichwas the date of the reforming of the policy of the exchange rate of RMB, to seewhether the relationship between the relevance of exchange rate and output volatilityis different from the overall researching period.At last we make a summery of the empirical analysis above and concluded.