The Construction And Application Research Of RMB Effective Exchange Rate

On July 21,2005, China began to reform the exchange rate regime by moving into a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. RMB would no longer be pegged to the US dollar but float with reference to a basket of currencies and form a more flexible exchange rate mechanism. In the trade area, the foreign trade scale continues to expand and the number of trade partners keeps growing. China has established trade partnership with 231 countries in the world by 2014. The new exchange rate regime reform and China’s actual trade circumstances require us not to peg to US dollar in RMB exchange rate but focus on the changes in exchange rates between RMB and the currencies of China’s main trading partners, which means that we should observe exchange rate changes from the perspective of effective exchange rate.Compared to bilateral exchange rate, RMB effective exchange rate reflects the overall currency value and macroeconomic situation and foreign economic relations faced by China. A comprehensive and accurate measure of effective exchange rate will make it play the role of indicating international competitiveness, converse the public view from bilateral exchange rate to effective exchange rate and provide a scientific basis for our country, the enterprises, institutions and individuals to avoid exchange rate risk.According to the actual foreign trade and foreign direct investment situation in China and considering the official disclosed currency basket constitution principle, this paper selects the U.S. dollar, Euro, Japanese yen, Korean won, Singapore dollar, British pound, Malaysian ringgit, the Russian ruble, Australian dollar, the Thai baht and the Canadian dollar as the basket currency and constructs the RMB nominal effective exchange rate index and the real effective exchange rate index from July 2005 to December 2015. When computing the currency weights, different from the common practice of only considering bilateral weight in most previous studies, this paper considers not only direct competition effect but also "third market competition effect" and constructs a complete double weight system based on the SITC5-8 manufacture goods to measure the importance of each currency in RMB currency basket. At the same time, the weight is updated yearly to reflect the developments and changes in China’s foreign trade.This paper compares the nominal and real effective exchange rate indexes based on double weight system with those calculated by the bilateral weight method and BIS method. The results show that the double weights considering "third market competition effect" are different from the simple bilateral weights, indicating that the "third market competition effect" will impact the calculation results of currency effective exchange rate indexes; In addition, the double weights of the same currency are different in each year, indicating low weight update frequency will affect the accuracy of RMB effective exchange rate index. Apart from that, the trend of RMB effective exchange rate based on "third market competition effect" is similar with those calculated by bilateral weight and BIS weight but differ in amplitude of variation, which shows that the selection of different weights has a significant impact on the results of the effective exchange rate index, on the other hand, the results illustrate that the RMB effective exchange rate index calculation results are also sensitive to currency selection. As a result, appropriate currency basket should be determined according to the actual situation in China. The paper also analyzes the trends and fluctuations in the RMB effective exchange rate since the "exchange rate reform" and selects export trade and foreign direct investment inflows as an example to study the influence of the RMB effective exchange rate changes on China’s trade and investment.The paper is organized as follows:The first chapter is introduction. This part introduces the background and significance of the research on the effective exchange rate index, clarifies the ideas and research methods and points out the innovative parts and the shortcomings in the paper.The second chapter is about related concepts and research summary, this part introduces the concept of the exchange rate, the nominal exchange rate, the real exchange rate and the effective exchange rate, combs researches on effective exchange rates, including key foreign organizations such as the International Monetary Fund, the Bank of International Settlements, the European Central Bank and the national central banks such as the Federal Reserve and Bank of England. This part also introduces RMB effective exchange Rate index research of major domestic research institutions and scholars.The third chapter is the methodology. This part describes the main steps of calculating the effective exchange rate index, such as currency choice, deflator selection (which is used to calculate the real effective exchange rate index) and the trade weight construction. The weight construction part describes the bilateral weight model, the multilateral exchange rate model, the global trade model and the double weight model.Based on the methodology in the third chapter, the fourth part selects 11 currencies to form the currency basket according to China’s trade and investment and calculates RMB nominal effective exchange rate and the real effective exchange rate from July,2005 to December,2015 based on the double weight model taking into account of "third market competition effect". By comparing the effective exchange rate with that based on bilateral weight and BIS method, this part addresses the importance of weight construction and currency basket selection in the process of calculating effective exchange rate.Chapter five is applied research. This chapter adopts the RMB effective exchange rate index calculated in the fourth chapter to analyze the volatility of the index. This part also selects export trade and foreign direct investment as an example to make an analysis of effect of the real effective exchange rate changes on China’s trade and investment.The final part concludes the paper and outlooks the improvements in order to provide reference for future and further study.