RMB Exchange Rate Non-complete Pass-through To CPI

In an opening economic system, the exchange rate and domestic price reflect the external and internal price of a country's currency, so that their importance is noticeable. Based on "law of one price" and "purchasing power parity theory", international price can be transferred into domestic price though the exchange rate. The volatility of exchange rate can lead to import and export price change in the first place, then affect balance of trade and domestic price through spending conversion effect, which in turn has influence on domestic production and consumption, and finally bring about adjustment of one nation's internal and external equilibrium. On the other hand, domestic price is closely linked to the lives of residents, its stability is connected with nation's sustainable development and social stability. Thus, the relationship between exchange rate and price level is always a concern.Traditional open macro-economic theory is based on law of one price and purchasing power parity theory, which believe the transfer from exchange rate movement and price level is sufficient and complete. after the sign of Plaza Accord in the 1980, however, incomplete exchange rate pass-through becomes an important topic.At present, as for incomplete exchange rate pass-through, there are plenty of literatures about developed countries. Researches on our country have come forth since exchange rate reform in 2005.However, subject to the limit of sample time span, those researches concentrate on discussing the extent of incomplete exchange rate transmission before and after exchange rate reform from a macro perspective. But few covered the transmission mechanism from exchange rate to overheated economy before financial crisis as well as slowing down economic growth in post-crisis era.In particular, since the reform of the exchange rate system in 2005, the volatility of the RMB exchange rate tends to increase. With the fact that current account and capital account are surplus and the domestic inflationary continues to increase, RMB is facing enormous pressure to appreciate and China's economy is facing serious internal and external imbalances.Therefore, the change of the RMB exchange rate has a strong influence on the domestic price level, showing some new phenomena and new features. Since the end of 2005, RMB appreciate against most other currencies. On the other hand, RMB depreciate against the internal. According to the traditional theory of international economic, A currency that continuous appreciate against foreign currency should appreciate against internal. Thus, in theory, the RMB appreciation is an effective way to reduce the trade surplus and domestic inflation mitigation, but the situation in practice was completely contrary.Under this background, conducting a deeper research on transfer effect mechanism is significant. It can help enriching our country's research status, and improve acquaintance towards the substance of price volatility, the trend of inflation, and the effectiveness of monetary policy. This paper applies autoregressive distributed lag approach (ARDL) to explore the incidence and influence mechanism between exchange rate movement and domestic price level, thus verify whether appreciation of RMB exchange rate can curb inflation. Furthermore, this paper discusses whether there is a connection between RMB's external appreciation and internal devaluation.ARDL model has many advantages:firstly, it relaxes variable stationarity assumption; secondly, this approach can help work out the long-term and short-term transfer coefficient for influence on CPI from exchange rate; lastly, it makes research about asymmetric influence on CPI form RMB's appreciation and devaluation possible.During the empirical analysis process, this paper chooses monthly data from July in 2005 to December in 2015, and constructs ARDL model and asymmetric development model. Main results are as follows:Firstly, movement of RMB nominal effective exchange rate has apparent negative transfer effect on CPI in both short-term and long-term aspects, which means, the appreciation of RMB will lower the CPI index, and thus can curb inflation. But it also means the empirical results cannot provide evidence or explanation to RMB's external appreciation and internal devaluation.Secondly, the transfer coefficient of exchange rate fluctuation to CPI is far less than 1, and has lag effect. This is consistent with other scholars empirical results about incomplete exchange rate pass-through.Thirdly, the pass-through effect from RMB exchange rate and CPI has slight asymmetry. Every one percent increase in RMB's appreciation will lead CPI to decline 0.1279 percent; every one percent decrease in RMB's devaluation will cause 0.1317 percent of CPI's decrease.Fourth, in the short term, the asymmetry that the RMB exchange rate pass-through effect asymmetry presents is so slight that it can be ignored. The influence coefficient, which stands for the degree of the change of RMB exchange rate influences CPI, is very small. In the short-term error correction model, coefficient is significantly negative and the numerical value is small, indicating that the speed that the variable from the equilibrium level of short-term deviation returns to the long-run equilibrium is relatively slow. After considering the changes in the direction of exchange rates, coefficient expands and the error correction mechanism enhances. However, this enhancement is still very limited.Fifth, change in CPI was mainly influenced by its own inertia and the world price level, followed by the RMB exchange rate and domestic demand. And in consideration of the direction of changes in exchange rates, the empirical results are broadly consistent with the conclusions.Finally, this paper makes stability test on ARDL model and asymmetric model. The result shows that the models established in this paper empirical are reliable, short and long term coefficient are stable and effective, and empirical estimation results are credible. The model constructed in this paper, is concerned only with the effect of changes in the direction of the exchange rate on pass-through effects. So the follow-up studies could include the exchange rate fluctuations and other factors, and make further research on the asymmetric effect.In addition, this paper points out some policy implications in the end.