Changing anchor of the renminbi: A Bayesian learning approach to the decade-long transition

Abstract

China’s exchange rate reform, initiated in 2005, had the goal of switching from a fixed U.S. dollar (USD) peg to a floating mechanism with reference to a trade-weighted currency basket. Over a decade of gradual transition, the renminbi (RMB) has gained importance in the international monetary system and has shown higher flexibility in its dollar value. However, previous studies have demonstrated the inertia of the RMB in maintaining a de facto dollar peg, with little evidence of the up-to-date effectiveness of the official currency basket. We present a Bayesian time-varying coefficient regression on the currency peg or basket weight suitable for studying transition process. We show that the exchange rate policy reform in 2015 triggered an eventual anchor switching, driving down the dollar weight from 1 to around 0.3. Since 2016, the weight of the official basket has been double that of the USD. SVAR and TVP-VAR analysis, controlling for endogeneity, provide consistent evidence of this regime change, which has important implications for China and the global economy. • China’s exchange rate regime had a strong inertia in keeping up a de facto dollar peg. • Little is known of the role of the official currency basket in RMB value formation. • We use Bayesian learning approach to evaluate the RMB’s changing anchor process. • The “8.11” reform in 2015 triggered an eventual departure from the dollar peg. • Since 2016, the weight of the official CFETS basket has been double that of the USD.