Abstract: The paper studies the equilibrium real exchange rate of the RMB and exchange rate misalignment in an open economy New Keynesian-DSGE framework. The result shows that the RMB was under-valued by about 15% from the equilibrium level before 2005, but the misalignment was reduced significantly since the exchange rate reform in 2005. In recent years, the RMB exchange rate “imbalance” hovered in a narrow range around zero, suggesting that the exchange rate is close to the equilibrium level and that economic fundamentals do not support sustained and significant appreciation of the RMB. Our analysis also shows that the choice of exchange rate regimes and openness of the capital account have a limited impact on the long-run equilibrium level of the RMB, but may significant affect its volatility. The paper suggests that the RMB exchange rate flexibility should be further enhanced in order to avoid the market expectation of “one-way appreciation” and the re-emergence of current account imbalance in the future.
Full report :Equilibrium Real Exchange Rate of the RMB and Misalignment .pdf
