Study On Linkage Mechanism Between Exchange Rate And Interest Rate In China

Exchange rate and interest rates play an important economic role in the nationaleconomy of our country. The interest rate is the domestic currency price of money,the exchange rate is the prices of foreign exchange funds. They are interrelated.Theexchange rate is the conversion of the interest rate, according to the interest rateparity theory, the high interest rate of long-term interest rate becomes slower, the lowinterest rate of short-term interest rate becomes higher; when a country to raiseinterest rate, it will cause the inflow of hot money, the formation of the bubbleeconomy for short-term profit will flow away rapidly, and eventually the bubblewill burst.The relationship between exchange rate and interest rate has aroused the interestof many economists who do some research about the relationship between exchangerate and interest rate. This paper begins with the general principles of the linkagebetween exchange rate and interest rate,following with several basic model oflinkage between interest rate and exchange rate, and do research for financialliberalization in developing countries, then described the interest rate parity theorymodel under the opening financial market of our country by empirical research aswell as the feasibility of application，make recommendations for financial marketliberalization in China.The first part is the introduction. This part describes the background andsignificance of this article. Do a summary of the research for linkage betweenexchange rate and interest rate on domestic scholars, and then make a description ofthe innovation and insufficient of this paper.The second part studies the theory of exchange rate and interest rate conductionmechanism in china. This section summarizes the scholars theories in the past, itdescribes this from the view of the current account, the view of the capital account,the view of asset conversion and the view of a fixed exchange rate system under the foreign exchange reserve, following with well-known model, such as interest rateparity model, flexible price monetary model, prices overshoot model, Mundell-Fleming model.The third part, China’s exchange rate policy’ and interest rate policy’ changes inthe law and the empirical research of the linkage. At first, this section summarizesChina’s exchange rate policy’ and interest rate policy’ changes in the law, and thentakes the interest rate parity model as a starting point for analysis, selects theone-year deposit rate and domestic U.S. dollar interest rate to do the research. Inorder to enhance the persuasiveness of the findings, the paper removes the impact ofinflation on the results, does the research by forms and icons, and then does theGranger causality test, concluding the relationship of theoretical and practical fitpartly, namely interest rate parity theory in China is not justified.The fourth part studies why the linkage mechanism of exchange rate andinterest rate in China is not obvious and make policy recommendations. This part ofthe reasons for why the linkage between China’s exchange rate and interest rateeffect is not obvious is that the perspective of exchange rate and interest rate systemis in conflict. This part describes the conflict of exchange rate policy and interest ratepolicy in chronological order, and then describes the control of the exchange ratepolicy and interest rate policy impact on the economy. From the exchange rateregime reform, the interest rate system reform and capital account reforms putforward policy recommendations. These recommendations include arrangements forthe timing of capital flows, interest and exchange rates reform, to avoid causingexcessive impact of the policy conflicts in the process of financial liberalization onthe economy; speed up the process of marketization of interest rates, make flexibletransmission mechanism between exchange rate policy and interest rates policy;make the exchange rate marketization, and improve the exchange rate formationmechanism, make the endogenous linkage between exchange rate interest rate; relaxthe capital control gradually, make formation of capital account openness and thefree convertibility of RMB, and enhance the linkage between exchange rate-interestrate mechanism for the international mobility of capital.