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

It’s well known that the transmission mechanism decides the monetary policy’s realeffects on macroeconomy. Exchange rate transmission channel is one of the mostimportant channels in monetary transmission mechanism. Under the background ofChina’s open economy, the study on exchange rate transmission mechanism has holdgreat significance for effectiveness of monetary policy.This essay introduces the research achievements of monetary transmissionmechanism both at home and abroad in chapter one. Then it elaborates three kinds oftheoretical models on this topic in chapter two, and uses the third model, small openeconomy model, as the basic model for this essay. In empirical analysis, chapterthree, the author builds two models: VAR and DSGE models. The essay verifies thatthe exchange rate transmission process like monetary policy—exchange ratetransmission—economic fluctuation is very obvious in VAR model. Then it constructsDynamic Scholastic General Equilibrium model on the basis of Small Open Economyto make up the deficiency of micro-based agents in VAR model. This dissertationemploys Bayesian methods to estimate linear equations’ parameters in DSGE, and usesthe simulation results to analyze the transmission process and reveal the idealconditions for successful exchange rate transmission. Based on empirical study, thisdissertation draws some conclusions:First, the effect of transmission from interest rate to exchange rate is very distinct,and the transmission from exchange rate to terms of trade has more obviouseffectiveness than to consumer and investment. As the result of that, international tradechannel is the most important channels in exchange rate transmission mechanism.Second, the smoothed estimations of exogenous stochastic shocks in DSGE modelshow that this dissertation’s DSGE model successively depicts China’s economy. Thisessay also demonstrates the feasibility of interest rate as the intermediate target ofChina’s monetary policy with a modified Taylor Rule.Third, the result of simulation proves that exchange rate will play a more importantrole of transmitting monetary policy under some conditions like more open economy,higher elasticity of institution, lower price stickiness. And the exchange ratetransmission will perform much better in the inflation-targeting economy.