China Foreign Exchange Market: Evidence Of The Rmb Exchange Rate Misalignment

The undervaluation of the Renminbi and its future trend has been an important issue for both Chinese and international scholars over the past few years. Many authors made the conclusion that the Renminbi is highly undervalued based on the equilibrium exchange rate models (PPP, BEER, FEER) without considering the underlying assumptions carefully.This thesis analyzes the common equilibrium exchange rate models for their application in the Chinese situation, and finds out that the PPP and FEER are not always appropriate when applied in the special situation of China. Therefore, the thesis tries to define the misalignment of the Renminbi by using the BEER model with the variables: terms of trade (tot); relative price of non-tradable products to tradable products (tnt); net foreign assets (nfa), and broad money aggregates (m2).The result shows that the misalignment of Renminbi in 2007 can be estimated at 26.08%. Then, the thesis analyzes the relationship of the Renminbi's misalignment and the current economic problems in China based on the BEER's result.All in all, our conclusion is that the Renminbi is undervalued, but the undervaluation is not the only source of all the current economic problems in China. The above empirical results have important policy implications: i) the appreciation of Renminbi should not be done in hurry, (ii) the government could first widen the bond for Renminbi exchange rate to fluctuate, and peg to a basket of currencies rather than simply to the USD.