The Determinants Of RMB Exchange Rate Volatility

In July 2005, Chinese Central Bank formally proposed the managed floating exchange rate system, which started the market-orientation reform of the RMB exchange rate. In the following exchange rate reform period, the volatility of exchange rate increased, with continued appreciation turning into devaluation. The RMB against the U.S. dollar showed a significant appreciation trend from July 2005 to 2014, with the cumulative appreciation of 29.09%, while the exchange rate began to depreciate from 6.11 to 6.45 since 2015.With developed countries’severe economic situation and China’s domestic growth languish, will the RMB exchange rate changes will appear some new features? What is the RMB exchange rate formation mechanism? How to accurately estimate the determinants of exchange rate volatility and forecast the trend? This paper will focus on these problems.Based on the application of the exchange rate decision theory in China, this paper firstly reviews the history of the RMB exchange rate. Then considering the impact of economic factors, institutional factors, market expectations and other factors, the paper divides these factors into long-term and short-term types according to their time effect on the exchange rate. Secondly, it explores the impact mechanism of different factors and also preliminarily analyses the relationship between these factors and exchange rate. Thirdly, by using the Markov switching model, the paper empirically studies the degree of two types’impact on the exchange rate. At the same time, it determines the specific impact factor of RMB exchange rate in different stages. Finally, according to the empirical results, the paper provides some suggestions for the market-oriented reform of RMB exchange rate.The empirical findings of this paper are as follows. Among the eight long-term factors, the degree of economic openness, foreign exchange reserves, money supply, government fiscal expenditure, economic growth rate and terms of trade have a significant effect on exchange rate. A positive shock on the degree of economic openness, foreign exchange reserves and the economic growth rate will cause the appreciation of the RMB exchange rate, while the terms of trade will cause the depreciation of the exchange rate and the impact of money supply is uncertain. As for the five short-term factors, market expectations, the inflation rate and the international interest rate spread have the most obvious effect on exchange rate. In these factors, the inflation rate has a positive impact on the appreciation of the exchange rate, while market expectations results in the depreciation of the exchange rate and the impact of the international spread is uncertainty. Meanwhile, this paper also finds that the appreciation and depreciation of the RMB exchange rate could be determined by different factors at different historical stages. According to the empirical results, this paper argues that in the short term, the RMB exchange rate may tend to depreciate because the market expectation of devaluation is still heavy now and the inflation rate is still at a low level. But in the long term, the RMB exchange rate will not form continuing expectation of depreciation. One reason is that China’s foreign exchange reserves are still strong enough and the international balance of payments are also stable. And another reason is due to China’s relatively high economic growth rate. In the future, the central bank should reduce the intervention and improve market-based exchange rate formation mechanisms for the RMB. Meanwhile, the whole market should abandon the exchange rate fluctuations in a narrow range and adapt to the flexible bi-directional floating. What’s more, we should pay more attention to the RMB exchange rate index by referring to a basket of currencies. Last but not least, China need to accelerate economic restructuring and upgrading and steadily push forward the supply-side reform.