The Reform of China's Exchange Rate Regime

In July 2005 the Chinese government announced a switch to a new exchange rate regime. The new exchange rate regime is set with reference to a basket of currency. But the numerical weights of each currency in the basket are unannounced. Under economic and political pressures, China adjusted his exchange rate regime, which is no longer a peg to the US dollar. Subsequently, with the appreciation of the Chinese Yuan, China allowed a movement of the exchange rate up to 3% within any given day. Perhaps, the new exchange rate policy has an impact on the imports and exports, even other countries exchange rate policy, the international imbalance and financial market. We argue that China is not really conducting the basket of currency policy after the reform. The Chinese government released the composition of basket currencies and the determinant of currency weights. But the exact weights are still unknown. The methodology and results of this paper are easily summarized. First of all, we use the technique introduced by Frankel and Wei (1994) to estimate the currency weights. We find that the Euro and Japanese Yen are insignificant in the basket in terms of numeraire currency, the Swiss Franc and Special Drawing Rights. The results from Ordinary Linear Square show that China's exchange rate regime remains a peg to the US dollar tightly, because the weight of the US dollar is in exceed of 0.9. Then, following the regression results, we do F-test, rolling and recursive regression for the basket currencies. Moreover, we use Kalman Filter and Smooth method to test the significance of coefficient of each currency. We find that there is a slight decline of the coefficient, but it has no economic influence. Furthermore, we use Structural Break and Outlier method to test the significance of the coefficient of the currencies. The results show that the US dollar peg is still strong. That's to say, although China is conducting the new exchange rate regime gradually, the exchange rate policy is not a perfect peg to a basket of currency