A Study On The Relationship Between Exchange Rate And Price Level

Since Chinese exchange rate reform, the difference between the internal and external value of the RMB continues expanding, along with the appreciation of the yuan, China’s inflation rate also rises sharply, which is different from the classical theory of economics. The ubiquitous feature of the coexistence of inflation and currency appreciation is not unique in China, while the existing theories are difficult to make a reasonable explanation for this phenomenon.Exchange rate theory mainly includes purchasing power parity theory, interest rate parity theory, international payments theory, asset markets theory and so on, these theories based on different research perspectives give its own rational explanation to the determination of exchange rate, which can not give a satisfactory explanation to a universal reality of the coexistence of inflation and currency appreciation. Therefore, this article attempts to explain this phenomenon on the perspective of monetary functions. This is because the exchange rate as a kind of exchange proportion between different currencies, must ultimately be determined by the nature of the money itself, which is reflected in its functions, so the analysis of exchange rate determination must ultimately be found from the functions of money.Exchange rate is influenced by many factors, among which the price level is undoubtedly one of the most important. As a price between different currencies, exchange rate is mainly decided by the value of money, which is related to the capability of its executive function (influenced or determined by price level). This paper, supposing other factors are unchanged, is to analyze the effect of price level on the changes of exchange rate.At present, the domestic and foreign researches of this field are divided into two parties. One is on the traditional angle that treats currency as the measure of value, which is mainly embodied in the theory of purchasing power parity (PPP). In this theory, the exchange rate is inversely proportional to the price level, in the case of other conditions staying unchanged, the higher the price level of goods or services of a country, the less the purchasing power of money is. In that way, when the external value is decided by its internal value, leading to currency devaluation; On the contrary, when the price level drops, the exchange rate rises simultaneously. The other view on this topic is that money in a market economy should be regarded as a prepaid capital to gain profit. This suggestion argues that under normal circumstances, there is a positive relationship between exchange rate and price level, in other words, the higher a country’s price level is, the more nominal return that capital gains, the greater value of money acting as capital is, and the need strength for it is assumed to be greater, which pushes the exchange rates; Otherwise, the exchange rate is promoted to rise.Obviously, in reality, both functions of the money will play a role, thus changes in the price level will eventually lead the exchange rate to rise or fall, depending on the contrast between the two forces, when the power of the value of capital is stronger than the power of the value of scale, the exchange rate will rise; when power of the value of scale is stronger than the power of capital nature, the exchange rate will fall.So this article is based on a synthesized starting point of both monetary value and monetary returns. Picking the data of countries such as Australia and China as examples, this paper analyses the influence of price level on exchange rate. Through introducing the real exchange rate index to spin out two variables of value scale and return scale of money, and by the analysis of the weight, this paper’s main purpose is to verify in the present market economy condition, the main role of money is to act as the value measurement or capital.This study finds that both in Australia and China, for example, the influence of the price level on exchange rate is long-lasting and synchronous. The function of current money is to measure value, namely the higher the price level is, the weaker the actual purchasing power of money would be, as a result, the exchange rate drops, which is in line with PPP theory. As time goes by, the function of money as capital begins to emerge, the increase of the price level creates high capital return, and for the sake of profit-seeking attribute of International capital, large demand of money would be caused by high capital return, which results in the rise of exchange rate.Due to power contrast of the decline in the exchange rate caused by the value measurement to the rise of exchange rate owing to capital return, the role of the latter tends to be notable, so when setting monetary policy, the capital characteristics-of money must be fully considered. From the view that combines both value and return of money to analyze the relationship between exchange rate and price level, this paper can provide a theoretical basis for the economic development of China, achieving the stabilities of price, exchange rate, import and export.