Abstract
AbstractThis paper considers the effect of exchange rate (ER) level on China’s domestic prices during the period of 2003–2012. We examine China’s consumer price index (CPI), import price index (IPI) and producer price index (PPI) by using time series vector error correction analysis. The main finding of the paper is that ER pass-through has had a limited but growing effect on domestic prices and will continue to do so. ER regime change that was announced by Chinese government in 2005 led to an increased sensitivity of ER pass-through to domestic prices.
Highlights
As China has been further embracing globalization, exchange rate becomes an important economic index to reflect the status of the macro economy
We find that a shock on nominal effective exchange rate (NEER) has negative effect on consumer price index (CPI) which depicts that RMB appreciation will cause CPI decrease
We argue that a short-term pass-through channel from exchange rate to import price index (IPI) and producer price index (PPI) and to CPI is proved to be effective and smooth
Summary
As China has been further embracing globalization, exchange rate becomes an important economic index to reflect the status of the macro economy. It is a key factor linking international trade and capital flow. Since 2005, China has reformed the exchange rate regime to a managed floating system referring to a basket of currencies. China is urging further reform to improve exchange rate flexibility as part of plans to liberate China’s capital account. In the lead up to establishing a fully floating exchange rate, the fluctuation of the RMB will have more impacts on China’s economy, such as on the price levels in China
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