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The internal and external equilibrium and the equilibrium exchange rate of RMB China economy

Author: HeHuaCheng
Tutor: NieYe
School: Fudan University
Course: World economy
Keywords: Economic External and Internal Equilibrium Equilibrium Exchange Rate Exchange Rate Adjustment Cointegration Analysis
CLC: F832.5
Type: Master's thesis
Year: 2012
Downloads: 167
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Abstract


This paper starts the analysis from China’s external and internal imbalance and proposed that the nature of this imbalance is internal money supply imbalance which source from the external imbalance, namely the impact to the domestic money supply structure from the external surplus under the condition that China is a country with capital control and currency mismatch. Therefore, a major internal policy objective is to control the money supply thus inflation. Nevertheless, according to China’s national conditions, maintaining growth of GDP is also as an important objective of the internal balance, while maintaining a degree of current account imbalances will help to achieve this goal. The exchange rate will play its leverage property to become a policy tool to achieve these two objectives.Next, this paper analysis the relationship between RMB exchange rate and current account, as well as the domestic money supply, rose that the RMB exchange rate will play a role to maintain the desired current account surplus to a certain extent. And based on the Fisher equation us derivate the adjustment mechanism RMB exchange rate will have on domestic inflation rate. The former is China’s external balance target, and the latter is China’s internal balance targets.Then, based on the above mechanism us empiric the real economy and the results show that long-run equilibrium exists between the relevant variables. The long-run equilibrium (cointegration) relationship between exchange rate and external balance goals (desired current account percentage of GDP) as follows: CAGDPSAt=0.94×PPPt-0.52×IRPt-1.43×WECt+0.11CAGDPSAt stands for current account percentage of GDP (seasonally adjusted), PPPt stands for the purchasing power parity form of the RMB exchange rate, IRPt stands for the interest rate parity, WECt stands for the world’s economic output cycle.The long-run equilibrium (cointegration) relationship between exchange rate and internal balance targets (inflation) as follows: RMBt=1.25×CPIt-0.33×IRPt+0.001 RMBt stands for RMB nominal exchange rate appreciation (YOY), CPIt stands for the domestic consumer price index (YOY), IRPt are also the interest rate parity.Meanwhile, before in use of the PPP form of RMB Exchange rate, we calculate the PPP based bilateral nominal exchange rate of U.S. dollar against the Yuan, we found that the RMB exchange rate are in line with the relative form of PPP since the third quarter of1996to fourth quarter of2007, in line with the absolute purchasing power parity form first quarter of2008so far.Finally, according to the exchange rate’s role in the mechanism of the internal and external balance, we estimate the corresponding RMB exchange rate mismatch and calculate the corresponding equilibrium exchange rate. We found that except to sometime before the financial crisis of2008and2011to the present the RMB exchange rate lose its equilibrium to appreciate too much, other times RMB exchange rate is on its equilibrium level, basically.

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