China's Exchange Rate And Money Supply Changes And Inflation Relationship Study

Since the change of exchange rate in 2005, Chinese foreign exchange reserves have been growing as a result of the high double surplus of Chinese current account and capita] account Chinese foreign exchange reserve balance has exceeded 1,000,100 million U.S. dollars by the end of 2006, ranking first in the world. Despite of the revaluation of the RMB, it is still difficult to control the growth of Chinese exports, particularly high trade surplus with the United States which contrary to the traditional economic theory. At the same time, the growth of domestic economic is excessively dependent on exports and investment. The huge trade surplus has contributed to the growth of foreign exchange reserves, the monetary liquidity surplus in the economy, the extremely active capital market, the dramatic rise of money supply and the increasing of the prices. The Chinese large foreign exchange reserves can ensure the security of Chinese foreign exchange system, enhance Chinese comprehensive strength and foreign payment capability and withstand economic shocks from abroad.However, the huge foreign exchange reserves can result in a number of Chinese management problems. In order to maintain the exchange rate stability, the central bank has to purchase a large amount of foreign exchange from the foreign exchange market However, the way of purchasing foreign exchange can lead to the increase of domestic base money, which would result in the domestic inflation pressure up to some extent. If this pressure is handled properly, it will likely evolve into a comprehensive Inflation. This paper will explore the cause of these two phenomena and the correlation between two of them. The phenomenon of revaluation of the RMB and Inflation is unable to be explained by the traditional theory "purchasing power parity theory". Inflation and the exchange rate can not be simply linked together. The the U.S. loan crisis enhances these two phenomena, and that demands a higher standard for our study in this field.The purpose of this paper is to investigate the correlation between exchange rate of RMB to dollar, domestic money and supply domestic inflation This paper uses quantitative analysis and gets the point that the exchange rate of RMB to dollar have a negative correlation with inflation, and domestic current supply has a positive correlation with domestic inflation, and some resolution and suggestions are also presented in this paper.