Study On The Linkage Mechanism Between RMB Interest Rate And Exchange Rate

In an open economy, the efficient operation of interest rate market and exchange rate market comprehensively reflects a country’s economic development and allocative efficiency of resources. As two forms of currency price, interest rate and exchange rate are interrelated and interact on each other. They are important policy measures taken by the government to exercise macro-control, guarantee economic security and maintain financial stability. Interest rate policy is the basis of internal economic balance and exchange rate policy is the key to keep external economic equilibrium. The linkage relationship between interest rate and exchange rate is crucial to bring regulatory function, coordination and executive efficiency of relevant policies into full play as well as the internal-external balance. With the improvement of financial opening and economic extraversion, a consensus on the promotion of interest rate market and the establishment of flexible exchange rate mechanism has been reached theoretically and practically, but the true crisis still exists that the relationship between them isn’t well understood and further studied. Hence, how to protect domestic economy from being hit by linkage mechanism of interest rate and exchange rate as well as studying that of RMB and its practical impact is significant, which contributes to building a perfect, stable and efficient system for the market-oriented operation of interest rate and exchange rate and enhancing the financial market reform of China.This thesis considers that interest rate and exchange rate are considerable for macroeconomic and microeconomic operation as important levers. Therefore, it’s of great significance to study the relationship between them so as to judge the macroeconomic situation and predict its tendency. The main aspects are as follows:Firstly, the linkage between interest rate and exchange rate affects not only the transmission efficiency of macroeconomic policies, but also the monetary policies of central bank to coordinate internal and external balance. Secondly, when it comes to the influence of capital price in the capital market, interest rate and exchange rate are pivotal. The analysis and mastery of linkage between them is very necessary for investors to avoid risk and make steady profits. Finally, the linkage also impacts the operation of real sector. Furthermore, the study of it is significant theoretically. For one thing, interest rate and exchange rate play important roles in the process of monetary policy transmission as crucial variables. The discussion of linage relationship between them is of great guiding significance to realize internal and external equilibrium of monetary policies. For another, we can test and verify the theory of interest rate parity and that of purchasing power parity through empirical research of the relationship between interest rate and exchange rate.Considering the reality of China’s market-oriented reform, the applicability of traditional models and theories, such as interest rate parity and international balance of payment, is limited. As a result, when studying the correlation between RMB interest rate and exchange rate, we have to the effects of general theories and special situation into account during the period of economic transformation in China. Thus, this thesis follows the ideas and methods of combining theory and practice, integrating formal study and empirical study, analyzing the linkage mechanism in terms of classic models and traditional theories from multiple perspectives and considering the actual performance of economic operation. By testing and verifying the relationship among interest rate, exchange rate and other variables, it will give related assumptions to strengthen the effects of linkage mechanism.This thesis comprises five chapters:In Chapter Ⅰ, the author offers and introduction to the background and significance of this study, the research status at home and abroad, the ways of research, the frame, creativities and limitations.In Chapter Ⅱ, theoretical analysis on interest rate and exchange rate transmission mechanism is considered. The relationship between interest rate and exchange rate is studied from six aspects, i.e. theory of interest rate parity, balance of payment theory of exchange rate, monetary model, portfolio approach, Mundell-Flemming Model and Mckinnon-Ohno Model. Policy and system are considered firstly. The reform process of RMB interest rate and exchange rate as well as the conflicts between interest rate and exchange rate is included. Then the effects of market are stated, which cover the transmission mechanism of interest rate and exchange rate. Something about rational expectations, information sufficiency, market stability and political factors are stated in the end.In Chapter Ⅲ, actual analysis on linkage mechanism of RMB interest rate and exchange rate is stated. The author contrasts the effect of interest rate and that of exchange rate with the help of Economic Metrology methods like Vector Autoregression Model, Cointegration Test, Impulse Response Function, Variance Decompositon, Threshold Cointegration and Vector Error Correction Model.The last Chapter concludes this thesis with polices and measures taken to perfect the linkage mechanism of interest rate and exchange rate on account of current situation and actual results.This thesis has four characteristics. First, it focuses on the combination of theory and practice. Refined analysis of interest rate and exchange rate transmission mechanism is offered on basis of relevant theories. Besides, the theories are classified and concluded systemically. Second, when collecting the indicators for actual analysis, the author focuses on interest rate and exchange rate, which avoids the effects of statistics and the case that time series can’t get logarithm because of negative results. Third, money supply, foreign exchange reserve and foreign interest rate are considered in order to make the analysis more comprehensive and more persuasive. Last but not least, nonlinearly cointegrated relationship between interest rate and exchange rate is terrified with the help of threshold cointegration.Limitations can be found through this thesis. Firstly, owing to the indicator of interest rate and exchange, the explanation of economic essence may be biased. Besides, some important elements, like inflation rate and GDP, are not considered in the actual analysis of linkage mechanism. In addition, recommendations about policies and measures are not comprehensive and deep.