Purchasing Power Parity And The Equilibrium Foreign Exchange Rate For Renminbi

This paper begins with the introduction of Purchasing Power Parity's origin and development. After that, the relationship between Purchasing Power Parity and the equilibrium real exchange rate will be discussed. The pith of this paper is the depiction of the popular study methods on PPP and the study on RMB's Purchasing Power Parity based on that. According to the result of the study, the equilibrium real exchange rate will be determined for RMB. In order to investigate the purchasing-power parity (PPP) of RMB, I collected data of RMB's foreign exchange rates from 1980 to 2002 and consumer price indexes (CPI) of China, the United States, the United Kingdom, Germany and Japan. The study approaches include Regression Analysis, Unit Root Test, Cointegration Analysis and Panel Unit Root Test. The research result for RMB' long-run PPP is favorable using Unit Root Test, Cointegration Analysis and Panel Unit Root Test, but not as favorable as the other three study methods by using Regression Analysis. After looking into these study approaches carefully and comparing their similarities and contrasting their differences, I choose Panel Unit Root Test as the most appropriate study method for RMB, considering its limited data group and its transformation nature. By using Panel Unit Root Test, I reveal RMB's equilibrium real exchange rate as 1.11. In the last, after calculating RMB's real exchange rate for the year 2003 and comparing it to the equilibrium real exchange rate, I find it deviates downwards from the equilibrium real exchange rate, which shows the value of RMB is overvalued, not undervalued as some one expected. Therefore, I recommend maintaining RMB's current value, for it is based on RMB's long-run PPP.