The Model and Empirical Estimation of the Optimal Flexibility of RMB Exchange-Rate Regime: A Study Based on the Price-Stabilization

Abstract

Under the Mundell-Fleming-Dornbusch (M-F-D) framework, the paper develops a stochastic model to study the optimal choice of RMB exchange rate regime based on two objectives, namely the exchange rate stabilization and price stabilization. The paper finds that different policy objectives will lead to different optimal choices of RMB exchange-rate regime. If the central bank aims to stabilize the price level, the optimal choice would be a certain type of intermediate regime, or the optimal choice would be a fixed one if it aims to stabilize the RMB exchange rate. Based on the model, the paper empirically estimates China’s open economy parameters and uses them to estimate the optimal flexibility of RMB exchange rate regime. The paper points out that China should allow more exchange rate changes to absorb its foreign exchange market pressure in order to stabilize the general price level, which indicates that China should move toward a more flexible exchange rate regime.

Keywords

exchange rate regime flexibility / price stabilization / exchange-rate