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The Research on the Effect of Domestic Inflation to the Changes of RMB Exchange Rate Based on the VAR Model

Author: ZhuShanShan
Tutor: XuChaoZuo
School: Hunan University
Course: Finance
Keywords: RMB exchange rate exchange rate system reform price level inflation VAR model
CLC: F832.6
Type: Master's thesis
Year: 2012
Downloads: 153
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Since more than three decades of the introduction of the economic reform and thepolicy of opening to the outside world, the unification of China’s domestic market andforeign market is developing step by step. With the deepening of economicglobalization, China’s dependence on foreign trade is also growing rapidly, thuseconomic development is highly dependent on the import and export trade, and thedomestic price level is inevitably vulnerable to external shocks. In recent years,especially since the foreign exchange system reform in2005, the RMB exchange ratechanges frequently; simultaneously, the domestic inflation is more and more worse,thus forming the situation of both rise of the RMB exchange rate and price. Therefore,the study of the effects of China’s inflation due to the fluctuation of RMB exchangerate, for one hand it’s conducive to make us correctly understand the inhibition effectof the appreciation of the RMB exchange to inflation; for another hand, benefit fromthis study, in some extern it provide some policy advices to the direction and processof the RMB exchange rate system reform.First of all, the dissertation theoretically analyzes the inner link betweenexchange rate and the price, combs the intrinsic mechanism of the impact of thefluctuation of RMB exchange rate on the domestic price level, and makes a detailedexplanation to the theory of the exchange rate of pass-through; Second, based on theactual data since1994, the paper analyzes the exchange rate and inflation’s changeson the macroscopic view. Then, we adopt the monthly data from2000to2011toestablish the VAR(2) model with the independent variables of China’s consumer priceindex, RMB nominal effective exchange rate, exchange rate fluctuations level, GDP,broad money supply.And use Granger causality test, impulse response function andvariance decomposition analysis to explore how the fluctuation of RMB exchange rateaffects inflation. The empirical results show that the positive impact of a standarddeviation of the exchange rate and the exchange rate fluctuation, will bring the rate ofinflation with a reverse impact, about2%-7%of the fluctuations can be explained bychanges of the exchange rate. However, the impact is very limited, the biggest changeis less than0.1%; And we can see that the main factors of causing the inflation are theinflation expectations and the domestic real demands. According to the results of thetheoretical analysis, practical investigation and the empirical analysis, the paper holds that firstly we should maintain the stability of the RMB exchange rate level, avoidingto cause the domestic prices have large fluctuations. In the situation of the unstableexchange rate changes, we must make a reasonable scheme about the appreciation ofthe RMB exchange rate, and deal well with the economic growth and export stability.Second, orderly and steadily promoting the RMB exchange rate system reformprocess, enhancing the flexibility of RMB exchange rate and improving the foreignexchange market. Third, we should pay more attention to the expect of the inflation,the domestic real demand and other factors to control our inflation.

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CLC: > Economic > Fiscal, monetary > Finance, banking > China's financial,banking > Exchange rate,foreign financial relations
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