Introduction

Literature review

Estimation techniques

Results and discussion

Conclusions and recommendations

References

Abstract

This research paper investigates the effect of macroeconomic variables on the exchange rate USD/CYN using yearly time series data for China economy from 1980 to 2017. ARDL bounds test approach for cointegration is applied to test the long-run relation between the dependent and the independent variables. The results of long-run ARDL indicate that gross domestic product growth and trade openness have a positive effect on the exchange rate USD/CNY while interest and inflation rates have a negative effect on the exchange rate. Based on the results of this study, it is recommended that the policymakers of the Chinese government should implement vital monetary and fiscal policies to determine the less volatile and productive exchange rate for China to manage sustainable economic growth for a long time with its trading partners.

Introduction

Exchange rate is the value of one country’s currency into another country’s currency. Different economists argue that a flexible exchange rate is considered to be an important factor for any economy. Moffett et al. (2017) categorized exchange rate into four types. The fixed exchange rate is controlled by the government, which is using country’s reserves for a specific time period. Managed floating exchange rate is the rate based on the demand and supply of specific currencies under certain interaction of the government. Freely floating rate is the exchange rate that fully relies on the force of demand and supply at an open market, without any government interaction. The last type of exchange rate is pegged exchange rate – when home currency is pegged as compared to the currency of another country, and both countries are similar as compared to other countries’ currencies (Moffett et al., 2016; Piana 2001). Nowadays floating and pegged exchange rates are the most popular exchange rates. The floating exchange rate is adopted by the US, Europe, Japan for international trade and the currencies of these countries depend on how the currency trades in foreign exchange markets. Countries having international trade relation with other countries should maintain the stability of their currencies. To protect against the currency depreciation countries will choose to peg their currency for their exported goods and services.