Interest Rate Parity Perspective, The Linkage Of China's Interest Rate And Exchange Rate Policy Coordination

Interest rate and exchange rate are the two powerful adjustment tools of monetary market and foreign exchange market, and are also the main method of the Central Bank monetary policy, they have strong linkage restriction relations in the utilization and the conduction process. Not only the interest rate change has the influence on the exchange rate's formation, but also the exchange rate change has the influence on the interest rate level. At the same time, interest rate and exchange rate reflect various capital prices in different market. Both are important tools for adjusting macro-economy and realizing resources liquidity. The interest rate policy is the basis of internal economic balance, while exchange rate policy is the key of external balance. The coordination between interest rate policy and exchange rate policy is the precondition in internal and external economic balance. The analysis on the relationship of interest rate and exchange rate is significant theoretically and actually.Based on the theory of interest rate parity, this paper illustrates the linkage relations between interest rate and exchange rate theoretically. Then this paper analyzes interest rate and exchange rate in China from empirical study using the date of interest rate and exchange rate in China and America from 1985 to 2007, finds the effective interest rate exchange rate linkage mechanism does not exist in China. At the same time this paper finds out the reasons that the theory of interest rate parity doesn't work in China. They are the shortages of the theory of interest rate parity and the difference between the practice in China and the hypotheses of the theory. In view of the reasons, deal cost and coefficient of capital friction are cited and the model of interest rate parity is modified in order to explain the relationship between interest rate and exchange rate better in China. The paper find that the linkage between interest rate and exchange rate still exists in China in view of deal cost and system friction coefficient. With the acceleration of international economic integration process and the opening of China's financial market, deal cost and system friction coefficient will eventually become smaller and smaller, the theory of interest rate parity will works more efficiently in China. On one hand, this means that the relationship between interest rate and exchange rate will further strengthen. On the other hand, it also shows the risk of external will inevitably attack our country. Therefore, we have to plan ahead and steadily push forward the process of open and reform, and make use of the financial markets to set up a guard against the impact of the risk to avoid the financial crisis occur. Lastly, this paper gives some advice about how to enhance the coordination between interest rate policy and exchange rate policy harmony mechanism, including interest rate and exchange rate system reform.