A Study on the Relationship between Exchange Rate and Consumer Prices Based on ECM

ABSTRACT

One important issue of exchange rate pass-through is the extent to which exchange rate changes affect the prices. This paper studied the pass-through effect of movements in the RMB nominal exchange rate on consumer prices. In particular, we examined whether the exchange rate pass-through to consumer prices was complete or not, and the impact of exchange rate system reform had on the pass-through effect. To this end, the paper used the error correction model (ECM) to conduct an empirical analysis from the first season of 1994 to the last season of 2013 period. The results showed that the pass-through of exchange rate changes to consumer prices was incomplete. In the sample period, the exchange rate pass-through effect was on the overall downward trend. The exchange rate system reform caused structural changes in the pass-through effect. The overall pass-through effect was higher after the reform than before, and the passthrough was lagging. Finally, our results made suggestions to improve Chinese monetary policies.

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