Measuring Exchange Market Pressure On China And Empirically Researching The Relationship Of EMP And Monetary Policy

As a core economic relative variable in an open economy, exchange rate acts a very important role in the realization of macro-economic and external balance. With the acceleration of economic globalization and the enlarged openness of our economy, the RMB exchange rate reform attaches great importance to China, and a great number of foreign and domestic scholars and Chinese government were been paying attention to a list of policies relating to China. The RMB exchange rate policy is facing increasingly more and more difficulties.China's long-established export-oriented policies, preferential policies for foreign investment, international industry transfer, the flow-in of global excess liquidity, and our internal economic structural imbalance, resulted in the emergence of double surplus. In a managed floating exchange rate system, the balance of payments surplus results the surged foreign exchange reserves, leading to "sterilization" too much liquidity, as an important task of central bank. Under the current foreign exchange system, due to the rapid increase in foreign exchange reserves, the central bank's "sterilization" operations has become increasingly important, but the cost higher and higher. On the other hand, long-term upward pressure on the weakened central bank independence and monetary policy effectiveness of monetary policy, monetary policy is difficult to take into account the four economic goals. "Sterilization" brought huge foreign exchange reserves and released too much base money, making the central bank appeared to be inadequate, thus falling into the pressure of RMB appreciation and the dilemma of monetary growth. Meanwhile, the "sterilization" would lead to surge in market interest rates, leading to strong appreciation of the RMB under the pressure of a large number of foreign exchange, and offsetting the effect of "sterilization" policy. Since 1994 and 2005, the exchange rate system reform improved somewhat the RMB exchange rate flexibility, but in reality, this does not prevent the growth of double surplus and foreign exchange reserves. If the central bank of China is to ease the appreciation pressure through monetary policy, it would make the loose monetary market over loose, which may also stimulate the bubble on domestic asset market. In addition, the double surplus also brought a lot of trade friction between China and the partner countries.In a word, many of a China's external economic phenomena and greatly limited effect of monetary policy has reflected the pressure of RMB appreciation. Therefore, the measuring of pressure on the foreign exchange market is very important, not only contributing to a central bank's foreign exchange market operations and providing better predictors of mechanisms warning, but also helpful to analyse the main macro-economic variables. The research of pressure on the RMB exchange market, not only to the economists or the government, but also to multinational companies has important theoretical and practical significance. Objectively measuring the size of the RMB exchange market pressure and monetary policy and their relationships not only help to reveal China's foreign exchange market characteristics at the past ten years, but also help to further the future monetary policy researching and exchange rate reforms in decision making.This thesis closely around the core of the exchange market pressure index, using appropriate measurement methods and the newer and reasonable econometric techniques, to analyse the size of the RMB exchange market pressure and the relationship of exchange market pressure an the main macroeconomic variables. These studies will help further understanding of the exchange market and monetary policy.The whole thesis is divided into 5 chapters.The first chapter is an introduction section. The first section proposed the research background and significances. This section describes the ideas, organization structure of research, research methods and the could-be contributions and sOmething that could be inadequate.In the second chapter, the first section of the chapter briefly describes the definition of the exchange market pressure index (EMP). Then sort out the details of EMP index measurements at home and abroad in two very different methods--model-dependent EMP index approach (EMP-GRW) and the model-independent approach (EMP-ERW), and make a brief comparison of them. Based on the perspective of econometric methods, Sectionâ…¡sorted out literatures about the relationship of EMP and monetary policy in domestic and international area. The chapter also summarizes the typical empirical study of EMP measurement and the relationship between EMP and monetary policy. This chapter is to provide the necessary theoretical support to later analysis.The third chapter is the theoretical analysis one. The first section begins with a brief discussion of the major factors affecting China EMP and their negative impacts on the china economy. It would point out that economic growth, international hot money flow-in, the foreign exchange market and inflation is expected to be the main reasons to China's exchange market pressures, and also discussed the appreciation of the exchange market pressure on China's real economy, macro-controlling, financial systems and the negative Impact on China's exchange rate reform. Section II describes in detail the two main EMP index approaches (EMP-GRW and EMP-ERW), and make a detailed comparative analysis. Since EMP-GRW has many flaws and measurement errors at the technical point of view, we discuss the specific advantages of EMP-ERW approach. For empirical needs, this section combined with our practical choice for index calculation approach of the EMP-ERW. Section III is the second core of this chapter, this section first discusses the reason that why employ the MS-VAR approach to analyse the relationship between EMP and monetary policy and detailed the basic principles of MS-VAR approach. Finally, select four variables (real effective exchange rate, inflation, growth of money supply and foreign exchange reserves) to build a Markov state transition vector autoregressive model---MSIH(3)-VAR(P), for the analysis of the relationship between EMP and monetary policy.The fourth chapter is an empirical one. The first section detailed the data sources. Based on the EMP-ERW model constructed in Chapter II and the data from January 1996 to December 2010 data of China, the monthly EMP index was calculated. In the sample interval, the monthly EMP was divided three states and the time period was confirmed. Combining with China's foreign exchange market over the past decade, detailed analysis of the history will be made. EMP is divided into three states:moderate pressure of appreciation (depreciate) on RMB, strong appreciation pressure and the strong depreciation pressure state. Section II depicted the non-linear characteristics of EMP. Then I made a comparison between the MSI(3)-VAR(P) and MSIH(3)-VAR(P). Finally, we select the MSIH(3)-VAR(P) as a model for further analysis. Furthermore, combining with Section II of the EMP-ERW index calculated, MSIH(3)-VAR(P) is to achieve a better state recognition and time confirmed. Model also estimated the state transition probability matrix and the duration of each state. Furthermore, I have done detailed analysis of the relationship between EMP and monetary policy (including the impulse response analysis and the impulse response analysis when state transited), and briefly discusses some of the conclusions that are in-consistent with the traditional theory expected.Chapter V summarizes the full thesis.I believe that EMP-ERW is a more reasonable approach to measuring EMP index on China. Furthermore, I considered the non-linear nature of EMP, and point out that MSIH(3)-VAR(P) is more statistically adequate compared to VAR model, and got more conclusions compared late researches.First, from January 1996 to December 2010, China's EMP showed characteristics of regime-lasting and regime transition.Second, in any regime, monetary expansion will raise inflation, but RMB will be appreciated, and foreign exchange reserves increased, so come into increased EMP. This means that monetary expansion will devaluate RMB, but also has an effect of strong appreciation of it, and appreciation will be stronger than devaluation. I argue that this is because of a large part of the China's monetary expansion is absorbed by some industries of asset bubbles (such as real estate, capital markets, as well as some agricultural areas), and Promote the bubbles. So at the time being inadequate conditions of capital controlling, China's structural imbalance and the expected appreciation of RMB are likely to attract international speculative capital to flow into China. Therefore, the monetary expansion may not be an adequate policy. For the most commonly used measure of price level CPI, the price level should be included in its calculation, and reasonably determine and adjust its weight.Finally, at the relatively strong appreciation pressure regime, it has often continued and led to appreciation of RMB, increased foreign exchange reserves, thereby increased the appreciation pressure. And it is the same as when regime of moderate appreciation (depreciate) pressure transform to relatively appreciation pressure regime. I argue that this may be related to the "expectation of RMB appreciation".