Determination of Renminbi Equilibrium Exchange Rate, Misalignment, and Official Intervention

Abstract

We use an equilibrium real exchange rates (ERER) model to estimate the equilibrium exchange rate (EER) and hence the misalignment between the EER and actual renminbi (RMB) exchange rate with quarterly data from 1994 to 2012. The effect of various policy changes on this misalignment with a focus on official intervention is then examined. We find that the RMB EER rose 45 percent from 1994 to 2012, mainly due to trade policy and relative technological progress. The central bank’s (the People’s Bank of China) official intervention had quick effect on the misalignment, especially after 2005.

KEY WORDS:

• equilibrium exchange rate (EER)
• FDI
• foreign exchange intervention
• RMB appreciation

Acknowledgments

The authors thank Karyiu Wong, Yingfeng Xu, Toni Cavoli, Jimmy Ran, James Fraser, Hongwei Cheng, and seminar participants at Business School, Sichuan University, and 10th Annual Conference of ASEA for their helpful comments and suggestions. The authors also thank the editor and two anonymous referees for their highly constructive comments, which make this article more valuable.

Notes

1. At level, the p value (constant and trend) of LFDI is 0.0001, which denotes the rejection of the null hypothesis (a variable has a unit root) at the 1 percent significance level. Other variables, LREER (p = .2620), LHBS (p = .7276), LISHARE (p = .7589), LTOT (p = .9), LPLCY (p = .6423), LWPI (p = .1308), LDFR (p = .3281), all accept the null hypothesis. When we took first order difference, all variables passed the unit root test at the 10 percent significance level: DLREER (p = .0001), DLHBS (p = .0647), DLFDI (p = .0000), DLISHARE (p = .0001), DLTOT (p = .0006), DLPLCY (p = .0000), DLWPI (p = .0000), DLDFR (p = 0.0000).

2. During the Asian Financial Crisis, during the period from the fourth quarter of 1997 to the third quarter of 1998, the degree of overvaluation peaked at 9.9 percent in the first quarter of 1998. With the end of the Asian Financial Crisis, the overvaluation situation of the RMB real effective exchange rate began to lessen and return to an equilibrium value. In the period of the Dot Com Crisis, due to the recession of the American economy, China initiated foreign exchange intervention to maintain stability of the RMB, which led to an overvaluation of the REER. We can see evidence that there is a large overvaluation of the RMB during the end of 2000 to the first quarter of 2003. Influenced gradually by the Global Financial Crisis from the second quarter of 2008 when the financial crisis deepened, China narrowed the RMB fluctuation properly. Then the RMB repegged to the dollar. The RMB real effective exchange rate experienced significant appreciation, reaching a maximum of 9.6 percent in the fourth quarter of 2008.

Additional information

Funding

This article is supported by the National Natural Science Foundation of China (71072066, 71302183), the Social Science Fund of China’s Education department (14YJC790053), the Distinguished Young Scholars Fund of Sichuan University (SKJC201007, SKYB201402), and the Sichuan Provincial Social Science Fund (SC14C054). The usual disclaimer applies.