The Impact Analysis Of China's Exchange Rate Regime On Domestic Inflation

One currency reflects the exchange values of its own in two markets at the same time:one is domestic commodity circulation market, shown as its exchange rate with all kinds of commodities, or called the price of the commodities; the other is the foreign, exchange market, representing the relative parity with various foreign currencies. Theoretically, the values of the currency in the two markets should be in line, which means if the county is going through inflation, the foreign exchange rate will depreciate; on the other hand, if foreign exchange rate appreciates, the country should face a deflationary pressure.However, in the view of economic realities of China in recent years, as international trade surplus kept accumulating, the foreign exchange reserve has continued to increase, leading to appreciation pressure in foreign exchange market; at the same time, domestic price level has experienced serious inflation, and the price of consumer goods and asset rose sharply. It has become a remarkable phenomenon in the macro economy of China that external appreciation and internal depreciation of RMB co-exist.This paper tries to analysis the cause of this phenomenon from the perspective of foreign exchange rate regime and put forward some countermeasures. The article argues that in a more fixed foreign exchange rate regime and when foreign exchange settlement is compulsive, it has such conduction mechanism between appreciation pressure of RMB and domestic price level:the currency faces appreciation pressure, but maintains a fixed exchange rateâ†'the export goods gain price competitivenessâ†'current account has a surplusâ†'foreign exchange reserve keeps increasingâ†'base currency increasesâ†'inflation pressure appearsâ†'cost of export goods risesâ†'the price competitiveness of export goods decreaseâ†'current account surplus decreasesâ†'appreciation pressure of RMB remits. This paper uses the 1994 to 2010 quarterly data to empirically prove that the increase of foreign exchange reserve has a significant impact on the price level of China, whether in the long term or short term. Increasing foreign exchange reserve causes inflationary pressure.In the end, the paper puts forward some related policy recommendations attempting to provide some possible practicable options to resolve the existing contradictions.