Fluctuation of Exchange Rates Caused by Monetary Policy Divergence: Empirical Analysis between China and USA

Abstract

In the past ten years, because of the differences in economic history and social political scenarios between China and the US, the two countries have already experienced a divergence in monetary policy. Asides the domestic macroeconomic implications, the divergence would potentially cause changes and fluctuations between the exchange rates of the two currencies. Through theoretical analysis on macro and international economics as well as econometrics modelling utilizing Python and Stata-17, this research constructed a time series vector autoregression model quantifying the relationship between the USD/CNY exchange rate and monetary policy changes of both the US and China. This research found that the monetary policy changes in the two countries would not fundamentally change the USD/CNY exchange rate level but would cause fluctuations. Based on the findings, the article made recommendations for both central bankers and investors participating in the foreign exchange market to deal with the monetary policy divergence of the two major global economic entities.