Comparison Of The Effects Of RMB Exchange Rate On Domestic Inflation Before And After Exchange Rate Reform

Exchange rate and inflation represent the external value and internal value of a country's currency separately. As two important macroeconomic variables in the market economy, both of them have always been the focus of attention of the society and academia, and the relationship between them has become a hot research topic. According to traditional economic theory, the appreciation of renminbi should be helpful to restraining domestic inflation. However, since China implemented with the reform of RMB exchange rate regime in July 2005, RMB is no longer pegged to the dollar, and USD/RMB foreign exchange rate almost maintained the trend that going all the way up, while the domestic price level has always been high. We are faced with a situation that both exchange rate and domestic inflation are both rising. Based on relevant research about exchange rate and inflation at home and abroad, this article analyses the transmission path and transmission mechanism of RMB exchange rate. Using consumer price index, RMB name effective exchange rate, output gap, imported goods price index, interest rate, money supply and foreign exchange reserves this seven variables, with the exchange rate regime reform in July 2005 as the break point, we establish an autoregressive distributed lag model on the data before and after the Reform separately, and compare the exchange rate psss-through between them.Through theoretical and empirical analysis, the following conclusions were obtained. RMB exchange rate has a positive impact on the CPI before the Reform and the impact is small, while there is significant RMB exchange rate pass-through after the Reform, that when RMB exchange rate appreciates every one unit, CPI falls 0.815 units. The impact of foreign exchange reserves on the CPI has remarkably raised since the Reform. The output gap has little influence on CPI before the Reform, since the increase in money supply is the main reason of the rising inflation, rather than the relationship between supply and demand. And the effect degree of interest rate on domestic price is very small no matter before the Reform or after.As a result, the following policy recommendations are given in this paper. A perfect exchange rate formation mechanism should be established and we should improve the managed floating exchange rate system. By raising RMB exchange rate slightly and gradually, the domestic inflation can be restrained. At the same time, we should control the growth rate of money supply and foreign exchange reserves and prevent the influx of foreign hot money. To speed up the process of marketization of interest rates is also very important.