Sources Of Real Effective Exchange Rate Movements In China

The people’s bank of China renounces the original dollar-pegged exchange rate system and implements the new exchange rate regime which is a managed floating exchange rate system with reference to a basket of currencies, July 21,2005. RMB exchange rate maintains the overall trend of steadily increasing in the next decade until the financial crisis in 2008.In order to ease the exports pres-sure, the RMB pegged to the dollar again. When time comes to 2015,with the ex-pect of China’s economic slowdown and the United states to raise interest rates, the offshore RMB exchange rate fluctuated frequently. The RMB exchange rate not only affect economic growth, but also affect the relationship between China and other countries.Thanks to domestic and foreign scholars’persistent research.the exchange rate theory is being continuously improved and developed and produced many influen-tial theoretical models of exchange rate determination, for example, the Purchasing power parity theory, Mundell-Fleming-Dornbush non-equilibrium model, Stockman exchange rate equilibrium model, Balassa-Samuelson effect theory and so on. These theories have been widely used, but the sources of fluctuations in the exchange rate still have no consensus. Scholars choose different research objects and build different models, the conclusion is different. Therefore, the study of the real exchange rate movements has a very important theoretical significance.Most of the literatures which research the reasons of real exchange rate move-ments have adopted the vector autoregression model(VAR) methed which pro-posed by Blanchard and Quan(1989).For example, foreign scholar Lastrapes (1992) established a bivariate VAR model with a long-term constraint to identify the rea-sons of real exchange rate and nominal exchange rate fluctuations. He assumed that the real exchange rate and nominal exchange rate were fluctuated by two shocks, one is actual shock, such as resource endowments, production, technology, preference, etc, the other one is nominal shock, such as money supply. The empir-ical results show that whether at long time or short time, the actual impact is the main reason for the real exchange rate and nominal exchange rate fluctuation. For-eign scholars researching source of exchange rate fluctuation have been very ex-tensive and in-depth, but they still did not have a consensus, even research the same country, establish different models may have different conclusions. Com-pared with foreign researches, domestic scholars have just started research this problem. Most of domestic studies built on mature foreign research methods, for example, Chen Hao(2008) select three variations(real output, real exchange rate and relative price) to build a SVAR model to analyze the shock resources of RMB real effective exchange rate. The empirical results show that the impact of nominal shock on exchange rate fluctuations is very weak and this effect will disappear in the long term, demand shock and supply shock are the main sources of real effec-tive exchange rate fluctuation. What’s more, they proved the Balassa-Samuelson effect in China currently is not obvious.Contents of this paper is divided into three parts:(1)Through the establishment of four variables SVAR model, this paper will identify impact of four types shock on the real exchange rate of RMB. To make SVAR model be identified, short or long term constraints are need to apply to the model. (2)Through the impulse re-sponse and variance decomposition analysis, this paper will analyze whether the real exchange is a shock absorber or a source of shock. (3)In order to make the re-sults more accurate, this paper divides the time window into two periods, one is July 2005 to August 2008 and the other one is June 2010 to July 2015.Then we can compare the impact of the source of real exchange rate movements before and after the financial crisis.The empirical results show that:(1)The actual impact is the main source of real exchange rate fluctuations, especially the impact of demand shocks on the real exchange rate plays a dominant role. (2)The real exchange rate is a shock ab-sorber, not a source of economic fluctuations. (3) Empirical studies have shown that after the financial crisis, the impact of all types of shocks on real exchange rate fluctuations explanatory power has changed, although the actual impact still plays a dominant role in explaining real exchange rate volatility, but the currency impact is gradually increased. A positive supply shock will cause the real exchange rate to appreciate rather than depreciate afer the financial crises outbreak.There are two types innovation in this paper:(1)Since the output of GDP in China only have quarterly data, using GDP data will lead to the data would not be enough, so the paper selected industrial added value data instead of GDP data. (2)In order to analyze the dynamic changes of the shocks’impact on real exchange rate fluctuation, this paper divide the time window into two periods. There are also some shortages in this paper:(1)The selection of price index. The price index did not distinguish tradable and nontradable goods, so the non-trade factors may cause the model not accurate. (2)Since there are too many factors that cause the real ex-change rate fluctuated, we need to continue to improve the model and take more factors into consideration.This paper is composed of five parts.The first part is introduction. The second part is theory review. The third part is literature review. The fourth part is empirical study of exchange rate fluctuation sources. The fifth part is a comparative analysis of RMB real exchange rate fluctuation before and after the financial crisis.