Study Of The Relationship Of Rmb Exchange Rate And Interest Rate

Both interest rate and exchange rate, acting as the internal price and external price of a country’s currency respectively, plays an important role in the financial market and the commodity market. China has made great progress in interest rate marketization so far. The allowable RMB exchange rate floating range has been increasing as well. To research the relationship between RMB exchange rate and interest rate will do good for government to formulate effective economic policies to achieve internal and external equilibrium in the macroscopic aspect. And it will benefit enterprises and individuals through helping them make wise investment decisions. In the first place, based on traditional economic theories concerning the relationship between exchange rate and interest rate, this paper analyzes the conduction mechanism of exchange rate and interest rate from many perspectives. Next the paper analyzes the factors that affect China’s conduction mechanism between exchange rate and interest rate. The deposit and loan interest rate control, exchange rate floating range limit, the capital flow control, transaction cost, risk premium and other factors all have an effect on the normal operation of the conduction mechanism between exchange rate and interest rate. The paper then conducts empirical test on the long term and short term relationship between RMB exchange rate, China Interbank Offered Rate, and Federal Fund Rate. The empirical test methods mainly include cointegration test, impulse response function and variance decomposition based on VECM. The empirical result indicates that there is stable equilibrium relationship between RMB exchange rate and China Interbank Offered Rate in the long run, but the relationship between them is not obvious in the short term. At last the paper draws a brief conclusion and gives some policy suggestions.