Effective or Manipulated Crawling Pegged? Examining the Efficiency of China’s Foreign Exchange Markets

ABSTRACT

Through data on the balance of payments, this article examines the performance of the crawling peg system in China’s foreign exchange markets. We are interested in whether the exchange rates are steered by the market fundamentals or manipulation. We investigate the changes in market efficiency for the RMB against 12 major currencies in the past decade. Our findings reveal that even with a small floating band in China’s foreign exchange markets, if the market allows the exchange rate to adjust according to the price mechanism, then market efficiency does improve significantly. When the RMB was pegged to the USD at 6.83 during the global financial crisis, there was a severe market failure. That also occurred in 2014, when the China government began to depreciate the RMB to stimulate exports.

KEY WORDS:

• bootstrap method
• dynamic equilibrium model
• foreign exchange market
• GMM method
• mean reversion
• panel data
• persistency

JEL:

• C23
• C52

Supplemental Data

Supplemental data for this article can be access on the publisher’s website.

Notes

1. According to China central banks data, exchange reserves declined quickly in 2016, and in August 2016 hit their lowest level since December 2011, totalling $3.181 trillion. The outflow in 2016 is far larger than recorded in 2015.

2. China’s government announced the plan at the Asia-Pacific Economic Cooperation (APEC) forum on November 10, 2014; around the same time the U.S. Federal Reserve halted its QE policy; see in Appelbaum, Binyamin (October 29, 2014). “Federal Reserve Caps Its Bond Purchases; Focus Turns to Interest Rates”. The New York Times.

3. If we take away the means and trend, then we can neglect the intercept terms.

4. The 12 major currencies include the United States Dollar (USD), the Euro (EUR), the Pound Sterling (GBP), the Canadian dollar (CAD), the Australian Dollar (AUD), the Japanese Yen (JPY), the South Korean Won (KRW), the Hong Kong Dollar (HKD), the Singapore Dollar (SGD), the New Taiwan Dollar (TWD), the Malaysia Ringgit (MYR), and the Philippines Peso (PHP).

5. This report can be seen in Morrison and Labonte (2013).