Equilibrium Exchange Rate and Misalignment of the Chinese Renminbi: A Research Based on Montiel s Model and the BEER Approach

Abstract

In this thesis, we explore three aspects of the RMB’s equilibrium exchange rate. First, what is the appropriate definition of the equilibrium exchange rate? We argue that the Behavioral Equilibrium Exchange Rate (BEER) approach has many advantages in measuring the RMB's equilibrium exchange rate. Second, we develop a Vector Error Correction Model (VECM) for the RMB’s equilibrium real effective exchange rate (REER) using quarterly data from 1994Q1 to 2014Q4. From the model estimation, we identify the relationship between the RMB’s REER and several economic factors, such as productivity growth, terms of trade, etc. Third, we explore that the RMB’s equilibrium REER has been steadily appreciating throughout the sample period. We also calculate the extent of ‘misalignment’ and find that the RMB was undervalued from 2003 to 2007, while overvalued from 1997 to 2003 and from 2007 to now. Meanwhile, the extent of misalignment stayed within 10% on a BEER sense.