An Empirical Study On China 's RMB Interest Rate - Exchange Rate Linkage Mechanism

The interest rate is the price of one country’s currency on its domestic currency market, and the exchange rate is the price of the country’s currency on the foreign exchange market. Both of them are important indicators of one country’s macroeconomic performance. It has become the financial signal to judge the effective allocation of resources, the actual income of investment activities, and the adjustment of the internal and external economic equilibrium. They are important for the central bank to implement effective policy interventions, and they are also significant tools to maintain economic stability and financial security.For a long time, most of the public considered the main part of economic development as the high-speed growth in the gross domestic product (GDP). The government attached importance to the degree of trade surplus and foreign direct investment, and caused durative Double Surplus. Meanwhile, after being a member of the WTO, China would lose the protection of the strict control to capital flows. Due to the mandatory foreign exchange settlement system and the maintains of exchange rate stability in order to protect the export trade, the central bank turned on the monetary spigots to absorb foreign currency, so the domestic faced inflation pressure. The central bank’s monetary policy couldn’t be independent.For this reason, Chinese government has accelerated the pace of the exchange rate system reform and interest rate system reform. Economy development would depend on the market sensitivity and initiative more and more, not the authority of the government, which was difficult to achieve internal balance and external balance simultaneously. In this process, it is noticeable to concern about the linkage between the exchange rate and the interest rate. The linkage represents the smoothness of the transmission mechanism among the policy and the different markets. The commodity market, currency market and foreign exchange market would have more contact between each other when there is very obvious linkage. The economy status could be moved from the deviated position to the equilibrium position, which would free the visible hand of the government from regulating a series of complex intermediate targets. The policy tools are far less than the targets. This thesis attempts to start from the classic exchange rate determination theory, analysis the changes of the linkage between the exchange rate and the interest rate before and after the exchange rate reform in2005. Thus, the reform degree could be estimated and the meaningful recommendations and opinions could be made.There is always risk whether the reform be processed or stopped. It is especially important to study the successful or failed cases of other countries in their exchange rate reform or interest rate reform progress. Then the risk can be faced. Some representative countries or regions were selected and the success or failure reason was analyzed. The factors could be identified so it can be a reference to the reform progress of China’s exchange rate and interest rate reform. In the end, this thesis attempt to give political advices from four field-the exchange rate, capital flow, interest rate, the real economy-to the ongoing reform of the exchange rate and interest rate reform of China. It is necessary to actively promote the reform of exchange rate and interest rate, so the linkage between exchange rate and interest rate could have a positive effect in China’s economic development. And it is necessary to prevent the various risks that may be brought because of taking some wrong or inopportune approaches.