A Study On China’s Exchange Rate Transmission Effect Of Monetary Policy

Before the RMB exchange rate regime reform on July21,2005, a fixed exchange rate regime which kept a close watch on the U.S dollars and showed little influence onthe real economy was executed in China. After the reform of exchange rate regime, what RMB exchange rate pegs transforms from U.S dollars to managed floating exchange rate of a basket of currencies. In the meanwhile, exchange rate has attracted increasing attention in the transmission of monetary policy. How is the efficiency of exchange rate transmission of monetary policy? And whether the exchange rate transmission mechanism of monetary policy can make our monetary policy more effective after the reform are questions urgently expected to be clear.Firstly, this essay introduces the basic theory of exchange rate transmission of monetary policy and elaborates the two links in our exchange rate transmission mechanism. In the first link, monetary policy influences fluctuations in the exchange rate by influencing two intermediate targets, namely, supply and interest rate of monetary. In the second link, fluctuations in the exchange rate finally influence the realization of the ultimate goals of national monetary policy with the influence on the price level, trade balance and output level to judge exchange rate transmission effect of our monetary policy. On this basis, this essay tests the circulation of these two links through empirical analysis.Then, based on quantitative analysis, this essay reaches a conclusion that there’s a long-term, stable and balanced relationship among the money supply, interest rate and RMB real effective exchange rate.The increase in the money supply and interest rates will make the RMB real effective exchange rate depreciation, but monetary policy has slight influence on the fluctuations in the exchange rate. The relatively low exchange rate transmission effect of monetary policy is mainly attributed to our non-market-oriented interest rate and the failure of fluctuations in the exchange rate in reflecting changes of interest rate. In the meanwhile, with the increase in our funds outstanding for foreign exchange, the Central Bank adopts sterilized intervention measures to passively put monetary base into circulation with the purpose of maintaining the RMB exchange rate stable. Hence, monetary policy loses its independency to a certain degree. In the link where the realization of the ultimate goal of monetary policy is influenced by fluctuations in the exchange rate, it is demonstrated that the appreciation of RMB real effective exchange rate will lead to a decrease in trade surplus and the level of price and output. However, since RMB exchange rate transmission is incomplete, the fluctuations in the exchange rate will not be transmitted to the price level completely and thus influencing trade balance and the output level, the Central Bank influences net export with fluctuations in the exchange rate. As a result, the level of price and output shows insufficient effectiveness, and the exchange rate transmission of our monetary policy shows relatively low efficiency.This essay analyzes reasons influencing the exchange rate transmission efficiency of our monetary policy and puts forward that it can be enhanced by further advancing the market-oriented reform and perfecting RMB exchange rate regime reform, loosening capital control and changing the modes intermediate targets of monetary policy are selected.