An Analysis Of The Effectiveness Of China 's Monetary Policy In The Process Of RMB Internationalization

As RMB cross-border trade settlements and currency swap agreements have been approved by the government greatly in recent years, the internationalization of RMB has become a hot topic lately. In this case, the effects of monetary policy will definitely be affected. This paper aims to establish a theoretical model which combined the factor of internationalization of RMB based on the Mundell-Fleming model in an open economy. Theoretically owing to the internationalization of RMB, the output effects of monetary policy and the inflation effects of monetary policy changes a lot when comparing with those in an economy which RMB can only be accepted within the country. Before the empirical analysis is made, I come up with the Internationalization index of RMB applying the Principal Component Analysis method, aiming to reflect the current level of the internationalization. After that, by the OLS and VAR method, an empirical analysis of the effects of this internationalization on monetary policy is discussed.There are three main contributions of this paper. Firstly, though the availability of data related to the internationalization of RMB is poor, I select the Principal Component Analysis method to construct the internationalization index for RMB. This index goes well with the real economy and reflects the degree of the internationalization of RMB more accurately and effectively. This indicates that the index is more exact than former analysis, such as the assumption of simple equal weights in the index and the sole indicator.Secondly, in this paper, a modified Mundell-Fleming model is successfully constructed including the degree of internationalization of RMB. Through theoretical analysis of the difference between the slopes of the Balance of Payments (BP) curve and the currency market equilibrium (LM), the effects of monetary policy in this kind of context are analyzed. The results exhibit as that in this case, monetary policy will be less effective than that when RMB can only be accepted within a country.Thirdly, the effects of monetary policy on output and inflation are analyzed in all aspects, from the exogenous money supply to the endogenous money supply. And the inter-effects of factors such as output, inflation and monetary policy in the context of internationalization of RMB are also included in the analysis. Empirical results represent that the effects on output and inflation of monetary policy changes in this context. The output effect is not significant and the inflation effect is greater though the degree of the internationalization is very low. Judging from the Impulse Response and Variance Decomposition, the output effect will gradually be great as time goes. The inflation effect response greatly to the internationalization of RMB and the effect never goes down in the long run.Therefore, in this context of the internationalization of RMB, the monetary rules need to be more complex by taking the internationalization of RMB into consideration.