Hot money inflows and renminbi revaluation pressure

Yue MA, Huayu SUN

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

Abstract

Despite a series of revaluations, which started in July 2005, hot money has been sporadically sneaking into China in anticipation of further revaluations of the renminbi. In this paper we build a monetary model to show how anticipated revaluations lead to the instability of a pegged exchange rate regime. This model assumes current account convertibility and some degree of capital control, and fundamentally sound domestic policies and economy, as is the case in China. The model demonstrates that market-oriented interest rates can act as an automatic stabilizer to ease revaluation pressures, but cannot resolve them completely because the nominal interest rate has a zero nominal bound. Therefore, the official parity is difficult to defend and the revaluation expectations can be self-fulfilling, in the absence of external intervention. The empirical results of Granger causality tests are consistent with the main findings of our theoretical model. There are a number of policy intervention measures that can extend the life of a pegged exchange rate regime.
Original languageEnglish
Pages (from-to)19-36
Number of pages18
JournalJournal of Chinese Economic and Business Studies
Volume5
Issue number1
DOIs
Publication statusPublished - 1 Feb 2007

Fingerprint

Exchange rate regimes
Renminbi
China
Convertibility
Granger causality test
Capital controls
Current account
Anticipation
Automatic stabilizers
Policy intervention
Parity
Nominal interest rate
Empirical results
Interest rates

Keywords

  • Hot money
  • government intervention
  • pegged exchange rate regime
  • renminbi revaluation

Cite this

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Hot money inflows and renminbi revaluation pressure. / MA, Yue; SUN, Huayu.

In: Journal of Chinese Economic and Business Studies, Vol. 5, No. 1, 01.02.2007, p. 19-36.

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

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AB - Despite a series of revaluations, which started in July 2005, hot money has been sporadically sneaking into China in anticipation of further revaluations of the renminbi. In this paper we build a monetary model to show how anticipated revaluations lead to the instability of a pegged exchange rate regime. This model assumes current account convertibility and some degree of capital control, and fundamentally sound domestic policies and economy, as is the case in China. The model demonstrates that market-oriented interest rates can act as an automatic stabilizer to ease revaluation pressures, but cannot resolve them completely because the nominal interest rate has a zero nominal bound. Therefore, the official parity is difficult to defend and the revaluation expectations can be self-fulfilling, in the absence of external intervention. The empirical results of Granger causality tests are consistent with the main findings of our theoretical model. There are a number of policy intervention measures that can extend the life of a pegged exchange rate regime.

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