A Study On The Price Pass-through Effect Of RMB Exchange Rate: A Positive Analysis Based Threshold Vector Autoregression Model

Since our country adopted floating exchange rate system in January 1994, exchange rate system of China has experienced several reforms, and the formation mechanism of the exchange rate has become more complicated. At the same time, both fluctuations and influencing factors of the exchange rate have been becoming more complex. Therefore, it is more and more important and urgent to study exchange rate pass-through.This paper reviews three classical theories of the exchange rate, i.e., law of one price, purchasing power parity and pricing to market. We evaluate the influence of the three theories on the study of exchange rate pass-through, based on which we introduce the econometric model of the general form of exchange rate pass-classical by virtue of pricing to market. Secondly, we introduce the process of China’s exchange rate regime reform, the mechanism of exchange rate pass, the path of the exchange rate as well as three research methods to exchange rate pass-through, that is, ARDL model, VAR model and VEC model. We summarize the advantages and disadvantages of the three methods. We combine the advantages of VAR models and nonlinear models and use Threshold vector Auto-regression Model to study the effect of exchange rate pass-through on domestic prices. Taking inflation rate as a threshold variable, we consider effect of the RMB exchange rate pass-through on domestic prices. The effect of RMB exchange rate pass-through will change as the inflation environment changes. Considering consumer price index as the object and introducing 4 variables(the output gap, money supply, nominal effective exchange rate and inflation measured by CPI), we conduct an empirical by TVAR model, the data in which is monthly data from January 1994 to August 2013. After that, we apply LR test method to detect non-linearity of TVAR models, and plot the diagram of impulse response function to complete the analysis.The innovations of the dissertation are summarized as follows:① By virtue of bootstrap distribution, we run a test for VAR model against nonlinear TVAR model and confirm that TVAR model is better than VAR model.② Constructing a TVAR model by using the rate of inflation as threshold variable, we obtain inflation of 0.001175 and 0.006118 as a threshold. We also find that the exchange rate pass-through to domestic prices is significant in an environment of high inflation, but that it is not significant in the case of low inflation. We even gain that the effect of the exchange rate pass-through on the CPI and inflation is time-lagged in the latter case.