Interest rate, unemployment rate and China's exchange rate regime

Abstract

PurposeThe purpose of this paper is to discuss the change in China's exchange rate regime during the 2001‐2009 period, when both the pegged and floating exchange rates were adopted in the country, offering a rare opportunity to address the issue. The effects of China's interest rate differential (IRD) and unemployment rate on the exchange rate are also discussed in this paper.Design/methodology/approachGiven the economic variables are non‐stationary, this paper adopts cointegration analysis to evaluate the long‐term equilibrium in China's economy, with the unit root test, cointegrating test and a vector error correction model also used to scrutinize China' exchange rate regime for different time periods.FindingsThe time series data – including the exchange rate, IRD and unemployment rate – are used in the unit root test and Johansen test to verify the long‐term equilibrium between real exchange rate and unemployment rate in specific periods of time. Since the findings indicate no correlation between the exchange rate and IRD, it is possible to predict the value of Chinese yuan based on China's unemployment rate, but not IRD. China's government slows down the appreciation of its currency when the lagged unemployment rate is high.Originality/valueThe paper provides a fresh perspective on the long‐term equilibrium among China's exchange rate, IRD and unemployment by dividing the sample period into several parts, according to the exchange rate policy. The findings indicate that the unemployment rate plays an important role in China's exchange rate regime.