Purchasing Power Parity Theory And The Rmb Exchange Rate Of The Empirical Study

With the progress of internationalization and the development of Chinese market economy, setting reasonable exchange rates between RMB and other currencies has become a more and more important issue, which relies on a valid theoretical base. The starting point of the study about exchange rate is to find what are the basic deterministic factors of exchange rate in the long run. And purchasing power parity (PPP) is considered as a basic and explainable theory to play that role. PPP is the fundament of many existing articles about balance of payment and the determination of exchange rate, and as far as itself is a theory about the determination of exchange rate. This essay discusses the newest development of internationally theoretical and empirical studies of PPP. It emphasizes the relation between PPP and the Balassa-Samuelson thesis, and also emphasized the approach of test of PPP for RMB, panel unit root tests.The first part of the essay mainly deals with the Purchasing Power Parity Theory which includes three dimensions. I give a brief discussion about traditional Purchasing Power Parity Theory first, then the improved PPP with the consideration of capital account is put on. Finally the efficient markets view of Purchasing Power Parity is introduced and discussed in this part.In the second part, the writer discusses the Balassa-Samuelson thesis which is broadly considered as a very strong challenge to PPP. After a careful analysis about the basic ideas of PPP and the Balassa-Samuelson thesis, the writer finds that there are some complementary and coincidence in these two theories. Based on a solid analysis the writer discusses and expatiates a new explanation about PPP and gives some improved equations. In the last part, aiming at the problems in the empirical approaches of studies on PPP for RMB, which have been used, the writer adopts improved methods to retest it. This essay adopts four kinds of newly developed panel unit root tests to evaluate PPP for RMB over the 1978/1-2000/12 period, considering the possible structuralchanges of RMB. Results of our tests demonstrate: (1) The results of the time-segmentational tests of the real exchange rate of RMB since 1978 generally support PPP for RMB, and the results of test of half-life during 1994/1-2000/12 are even less than one year. That shows the exchange rates of RMB roughly confirm to PPP theory. We believe that a solid base for marketalization of exchange rates for RMB and free exchange of RMB with other currencies has been built up. (2) The results of the time-segmentational tests of the real exchange rate of RMB (especial 1994/1-2000/12) are better than those of one-single-time tests since economic reform(1978/1-2000/12), which implies that there have been structural changes in China from 1978 to 2000 indeed. That shows market economic system reform greatly affected the pricing system, and caused the structural changes of the real exchange rate of RMB. The speed of mean reversion of the real exchange rate of RMB is quicker, which shows RMB confirms to PPP much more. The results of the tests also demonstrate that the exchange rate regime reform in China is successful. (3) The degree of contemporaneous and serial correlation as well as heterogeneity of the series in the panels affects stationarity and the speed of mean reversion.