Double-layer monitoring model of exchange rate target zone and the choice of RMB exchange rate regime
Liu aiwen
Though Krugman’s target zone theory of exchange rate possess attractive policy implication,the model is rejected from presumption to conclusion in empirical study.The paper retransform the Krugman’s model with dividing layer and set up monitoring indicators,which leads to a lot of predominate performance;however,the new model need some other matching macroeconomic policy and perfection of market institutions in order to exert its functions.At first,the paper briefly introduce Krugman’s standard target zone of exchange rate,then retransform the model according to the inability of reality,and elaborate the the new model’s mechanism, policy implication and matching policies in detail;finally,the paper explore exit arrangement and future trend of current RMB exchange rate regime;conclusinonly,the paper think that double-layer monitoring model of exchange rate target zone will be desirable choice of RMB exchange rate regime for a long time.
Key words:target zone of exchange rate, equilibrium exchange rate,honeymoon effect,monetary shock,real shock.
1. Introduction
International exchange rate regime historical evolution show that both free floating exchange rate regime and hard fixed exchange rate regime all possess advantages and disadvantages. scholars that argue for hard fixed exchange rate only emphasize on the convenience which its nominal anchor function act on invest and trade, while those experts that support free floating exchange regime strengthen on the local monetary policy independence to which the free floating exchange rate regime leads to some extent. so there are the debate of so-called fixed and floating.However,decision-maker of all countries are afraid of turbulent free floating exchange rate regime between two world war and long-time real exchange rate misalignment which hard fixed exchange rate regime leads to under Bretton Woods system. They try to integrate the advantages of the fixed and floating exchange rate regime and build a exchange rate regime property of stability and flexibility, which is target zone of exchange rate.ERM March in 1979 was usually viewed as the exemplification of target zone theory of exchange rate.
The paper which follows begins in section 2 with a briefly introduction to Krugman’s target zone of exchange rate.Section 3 provides Double-layer monitoring model of exchange rate target zone.Section 4 provides 4. Supporting policies of the new model.Section 5 elaborates on the necessity and steps of implementing the new model.Section 6 provides a brief conclusion.
2. Briefly introducte to Krugman’s target zone of exchange rate
The earlist explorer to exchange rate target zone in theory is Williamsons,but Krugman put forward the strict theoretical model of standard exchange rate target zone in 1991(see graph 1).Krugman assume that exchange rate rely on current basic elements and future exchange rate expection,meanwhile,Krugman’s model still have two key assumptions,the first is that exchange rate target zone is completely credible,which means that its upper and lower limit will keep fixed;the second is that the exchange rate target zone safe guard by marginally intervention,namely monetary authority intervene only if the exchange rate move to the upper and lower limit of the regime,so there are on intervention in target zone.under the assumptions, exchange rate in target zone moving paths show “S” shape(see graph 1),from the graph 1,we can find that fluctuation range of curve TT (exchange rate behaviors of target zone) is obviously less than that of line FF(exchange rate behaviors of free floating regime),which means that completely credible exchange rate target zone have intrinsic stability mechanism. However the Krugman model assumptions of completely credible and marginal intervention have been rejected by empirical data（Flood et al，1991）.moreover, Obstfeld,M. and Rogoff,K also think that the model will confront the same problems as fixed exchange rate regime when exchange rate move toward the boundary of target zone（Obstfeld,M. and Rogoff,K.,1995）.based on those shortcoming of Krugman’s model,author transform it correspondingly,which is the following double-layer monitoring model of exchange rate target zone（see graph 2）.
3. Double-layer monitoring model of exchange rate target zone
3.1 design points
Considering that superiority and infeasibility in practice of Krugman’s model,we transformed it and divided fluctuation range into two layer,the fires layer is free floating band, namely S0～S1 range of graph 2,which government don’t intervene exchange rate movements;the second layer is monitoring intervention band,which band width is half of that of free floating band,namely S0～S'0 and S'1～S'1 of graph 2,government monitor the exchange rate move based on monitoring indicators;dashed line S0 and S1 is soft intervention line and government made it unknown to the public,if exchange rate move toward the S0 or S1,the probability of government intervention is very low;dashed line S'0 and S'1 is hard intervention line and government made it known to the public,if exchange rate reached the one of two lines,the probability of the government intervention is very high;finally,central exchange rate will adjust according to 1/2ΔB,which make the new target zone and original target zone overlapped.。
3.2 mechanism
Monitoring indicators of target zone includes exchange rate,interest rate,rate of inflation and duration time,through monitoring the status of indicators,we can distinguish between monetary shocks and real shocks,which determine central bank operate sterilized intervention or not or adjust the central exchange rate.when exchange rate stay in the monitoring band and interest rate surpass the monitoring indicator for a long time,it shows monetary shock,so central bank should operate sterilized intervention and central exchange rate should keep fixed;accordingly,when exchange rate stay in the monitoring band and the rate of inflation exceed the monitoring indicator for a long time,it indicates real shock and misalignment of exchange rate,so the central exchange rate should adjust with 1/2ΔB;when exchange rate stay in the monitoring band,meanwhile interest rate and the rate of inflation exceed the monitoring indicators,which measure should be adopted depend upon loss function of the central bank. through above analysis,we can find that automatic alignment function is peculiar to double-layer monitoring model of exchange rate target zone,which avoid exchange rate misalignment and stabilize the demand of invest and trade and achieve foreign economic in china. Moreover, the new model require that we must strengthen the fiscal discipline and implement the prudent fiscal and monetary policy and decrease the central bank ability for fiscal deficit.
3.3 policy implications
Exchange rate target zone model of double-layer monitoring possess those conventional favorite of krugman’s model honeymoon effect and decreasing the exchange rate fluctuation through dividing layer and setting up monitoring index,besides those above,it also has several benefits,as follows,at first,through setting free floating band,central bank needn’t intervene the exchange rate in zone,so more independence are endowed to monetary policy and central bank also behave against the economic circumstance according to the own economic cycle;secondly,because the width of exchange rate fluctuation is large than zero,central bank acquire the independence of monetary policy,meanwhile, the nominal anchor of exchange rate disappear to some extent,so speculative capital lose the attacking the target,which debase the speculative capital single side’s betting action;thirdly,for the width of target intervention zone is half of the width of free floating zone,if the based exchange rate readjust,the new exchange rate target zone is overlapped with the original exchange rate target zone,which avoid the leaping of exchange rate;finally,foreign exchange resource allocation become more effective,because exchange rate is determined by the supply and demand of foreign exchange market,it is well known that equilibrium exchange rate determined by market satisfy the principle of marginal cost amounting to the marginal revenue.
In a word, the new model design is accordance with gradual opening up of finance market in China. with the improving of Chinese economy,the width of free floating band will enlarge until fully free floating.
4. Supporting policies
In order that the new model normally operate,we must perfect the supporting policies.exchange rate policy,which is only a part of macroeconomic policies,must coordinate with other macroeconomic policies,so the predetermined policy goal can be reached.now we elaborate on the supporting policies related to the the new model from the following aspects.
4.1 Strengthening the regional currency cooperation
In a world with economy globalization accelerated,no country can be a refuge island during the storm of finance crisis and asia financial crisis in 1997 is an illustrative example.the crisis also impels that Asian countries and regions recognize the importance and urgency of the region currency cooperation.in a two-countries theoretical model of exchange rate, if two countries hold together to defend against the speculative attacks,the probability of successful safeguard is very high.perfecting operation of the model rely on coordination and cooperation of region currency policy,so we should strengthen currency cooperation of other asian country and establish the international coordination mechanisms so as to incorporated withstand the speculative attacks.at present,asian currency cooperation acquire initial fruits,in 1999,Mahathir,Malasian Prime Minister,put forward the suggestion of setting up “east Asia currency fund” and therefore promote the agreement on the “Chiang Mai Initiative” signed by 10 countries ASEAN plus China,Japan and Korea in May 2000,namely 10+3,which decide to enlarge the range of participation countries.at present,a series of bilateral money swap agreements have been signed among 10+3 countries.moreover,the cooperation formation,to utilize swap and buy-back to urgently aid to crisis countries,make of the asia currency cooperation institute foundation in reality. East asia economy all have amounts of foreign exchange reserve,by the end of 2007,there are 1530 billions foreign exchange in China,973.37 billions in Japan,262.22 bilions in Korea,270.3 billions in Taiwan region and 152.7 billions in Hongkong region,so these provide stability foundation for the new model implementing.
4.2 Reforming institutions of hampering production factors to flow,so forming internal dynamical mechanism of economic development.
The advantages of the new model is automatic alignment to equilibrium exchange rate;however,the precondition of the function is that market exchange rate fluctuate around the equilibrium exchange rate and these market, including monetary market,capital market and commodity market, can smoothly clear out. at present,China still have some structural probles and a lot of institutes which influence resources rational allocation still exist, which run counter to the intrinsic requirement of market economy.so,on one hand we need do our best to strengthen infrastructure construction, perfect the soft resources configuration,such as management and logistic, so as to eliminate the basic barriers; on the other hand we should reform the institutes hindering factors freely flow,for example,to impel RMB interest rate market reform,the reasons are that interest rate control easily lead to the problems of adverse selection and moral hazard,which form financial constraints and financial repression;moreover,economic agent throw themselves into rent-seeking incentively,which make resource allocation distorted and decrease social welfare.so RMB interest rate market lay a perfect foundation for RMB forward transactions,future transactions and avoiding exchange risk of Chinese enterprise,so as to perfect the RMB exchange rate forming regime; we still abolish the institute of hindering labor force to free flow,for example household registration system.by virtue of property right system reform, we can establish the mechanisms of state-owned enterprise and state-owned financial institues,so as to solve high risk and low efficiency of theirs;we also establish and perfect the self-employed system,which is the fundamental task of economy reform,in fact,self-employed system is not only increment reform,,but also it is the most important step which is overall orient-market economy reform and form intrinsic dynamic mechanism of economic development,meanwhile,it is the the best compensate and final entrance of poverty alleviation policy.
4.3 Perfecting forming mechanism of RMB exchange rate
Current RMB exchange rate forming is up to currency authority will,so its market foundation is very weak.as a result,in order that the new model operate boundly,we must cultivate mature and diversified market agent,develop diversified product,perfect the foreign exchange transaction mode and improve the exchange rate forming mechanism and so on.therefore,firstly we should release the condition of market access and cultivate mature and diversified market agent;secondly we must increase the kinds of market transaction,including several aspects,increasing kinds of foreign exchange transaction,developing RMB forward and future markets to avoid financial risk;thirdly wu should perfect the transaction mode of foreign exchange, that is to say,China should preferentially develop commercial bank’s market-maker system and popularize large number agency transaction.which may activate foreign exchange market and make exchange rate to reflect the expectation of market participant and make the price message function more remarkable;finally we should improve the RMB forming mechanisms and transform compulsory exchange surrendering system into a willing one,so as to clear the foreign exchange market out efficiency and form equilibrium exchange rate.
4.4 Reinforcing market supervision
For exchange rate regime don’t substitute for prudential supervision for financial system,Operation of the new model also rely on effective market supervision.reality of east asian financial crisis have proved that, in the global times, lacking of effective supervision and disordering liberalization would present international speculator the opportunity of making waves so as to amplify the original risk of financial system;moreover herding effect triggered by exterior speculator spread over domestic investors,which make capital market heavily distorted so as to cause hardly controlling financial crisis.so,in order to operate of the new model normally,firstly we seriously monitor the domestic balance sheet to avoid heavily mismatching of currency and maturity.secondly we need perfect the monitoring system,improve monitoring early-warning system,increase the supervision efficiency and control the market risk;thirdly we must vigorously reconstruct and normalize the foreign exchange market order,promptly grasp and precisely analysis the situation of foreign exchange fund flowing in and the trend of international balance of payment,severely strike all kinds of illegal foreign exchange transactions and illegal across border fund flow so as to prevent short-term speculative capital from swarming into our country;finally,we must improve the coordination mechanism of market supervision department.
5. The necessity and steps of implementing the new model
As a rapid developed emerging market economy, our country’s economic structure characteristic of Dualism Economy in urban and rural areas is comparatively obvious;meanwhile,after entering into WTO,China will confront complex economic shocks, not only including either interior or exterior shocks, but also including either monetary or real impacts; so these require that exchange rate regime both act as nominal anchor function and keep independent of monetary policy so as to adopt the complex economic situation,which is incompetent for current hard dollar pegged system.the new model,to some extent,both undertake nominal anchor function of exchange rate and keep monetary policy independent,meanwhile,the new model also possess automatic-alignment of equilibrium exchange rate,which is vital for Chinese exchange rate regime reform.of course,reform of RMB exchange rate regime must be impelled step by step,which means that the process of RMB exchange rate regime transforming into more flexible system also must follow certain steps.
5.1 Converting de facto single peg to dollar regime into peg to currency basket regime
Chinese foreign trade and invest increasingly diversified,for example,in 2003, total foreign trade value of major economy with China account for Chinese foreign trade value as following:American is 14.8 per cent;EU is 14.7 per cent;Japan is 15.7 per cent;Hongkong is 10.3 per cent;Asean is 9.2 per cent;Korea is 7.4 per cent. Single dollar pegged system only stabilize the bilateral nominal exchange rate of China and American,however,dollar,yen and euro are independent floating, so the system usually make RMB nominal trade weight exchange rate (nominal effective exchange rate) fluctuated, which aren’t favor to stabilizing the development of our country foreign trade and invest.so,in order to stabilize RMB real effective exchange rate,RMB must peg to a basket of currency,as for the currency selection in basket,we may select Chinese major trade partner currency and currency weight is proportion to their trade ratio according to ABC rule.
5.2 Broadening the range of fluctuation,while implementing exchange rate target zone model of double-layer monitoring
As a developing giant,China’s economic cycle hardly keep synchronization with other countries,which require monetary independence in China;however,China can’t implement completely free floating regime in view of imperfection of Chinese financial market.under this situations,we must increase flexibility of RMB exchange rate,on one hand we must broaden the RMB exchange rate floating range,on the other hand we must set upper and lower limit of exchange rate fluctuation in order to limit its excessive volatility,from this view,Chian should implement double-layer monitoring exchange rate target zone mechanism. considering real exchange rate volatility situations from 1994,the new model’s free floating band should adopt plus or minus 5 per cent and monitoring band should adopt plus or minus 2.5 per cent.in view of special situations in China,such as remarkable differential in regions and the structure characteristic of dualism economy,so the main goal of China’s monetary policy reach interior equilibrium,in turn,the rate of inflation should be adopted as the monitoring indicator.such arrangement guarantee both flexibility of exchange rate adjusting and stabilization of exchange rate fluctuation,which is in accord with the mode of China’s reform step by step.
5.3 Propelling capital account convertibility,thus realizing RMB free floating
At present, free convertible in current-account has been realized in China,but the foreign transaction in capital-account was still strictly regulated. in theory, foreign exchange regulation only have short-term insulating effect but can’t guarantee effectively the development of one country’s economy and finance for a long time.as a member of WTO,we must open the financial fields all-round,that is say,China’s economy will be influenced by global economy cycle to some extent.so we must reform financial management system accordingly so as to adapt to the new international situations.in the long run,capital account regulation isn’t a effective means,which isn’t favor of utilization of two resource and two market for China’s economy and hinder domestic resource effective allocating among international range,so we should eliminate the capital regulation step by step and accordingly establish sound,scientific and modern financial management system.according to the development trend of China’s economy,China is able to support RMB freely convertible and realize RMB single polar leaping,viz,free floating exchange rate regime,which means the market system establishment in China ultimately.
5.4 Implementing RMB internationalization
To realize RMB from free convertibility to free floating isn’t our final goal,which is phased goal at most.in reality,free convertible currency are a lot in the world,for example,theirs currency,such as Bulgaria, Estonia in east European and Latin America countries,are all convertible,but their currency was absent treatment for their economic power. Carlos’s empirical test indicates that currency free convertibility isn’t correlate to the economic growth (Carlos Arteta et al.，2001).so our monetary policy goal should be RMB internationalization.RMB become world currency,which promote international influence of China and RMB discourse rights,avoid risk of currency and maturity mismatching and increase seigniorage revenue for China. Above those is the necessity of RMB internationalization, sustainable development of our economy lay firm foundation for RMB internationalization; moreover, increasable maturity of China’s financial market and improvement of financial institution present reliable regulation guarantee for RMB internationalization.
6.Conclusion
After entering into WTO,china will face all kinds of economic impacts,including internal impact and external shock as well as currency impact and real shock. Double-layer monitoring model make honeymoon effect of target zone reappearing;what is more,its model is a self-stabilizing system. in the near and far future,the double-layer monitoring model of exchange rate target zone will be a desirable choice of RMB exchange rate system, moreover,it may act as the bridge smoothly leading to free floating exchange rate regime.
Bibliography
Eichengreen,B. et al.,1998,”Exit strategies policy options for countries seeking Greater Exchange rate flexibility”,IMF Occasional paper no.168.
Flood,R.P. and A.R. Rose,and D.J. Mathieson,1991,”Fix:of the Forward Discount Puzzle”,Review of Economics and Statistics,79,pp.748~752.
Krugman,P.,1991,Target Zones and Exchange Rate Dynamics,Quarterly Journal of Economics,106
Mishkin,F.S.1998.the economics of money,banking,and financial markets,Beijing,China Renmin University Press.
Obstfeld,M. and Rogoff,K.,1995,”The Mirage of Fixed Exchange Rates”,Joruanl of Economic Perspectives,Vol.9,No.4,Fall,1995,pp.73~96.
Sachs, J. et.al.1997.Macroeconomics in the Global Economy,Shanghai Shanghai Sanlian Press.
Shen guobing,2003.new choice of exchange rate regime—Some Inspirations for RMB Exchange Rate System,Beijing economic and scitific press.
Tang guoxing,Xu jiangang.2003.Research on Contemporary exchange rate theory and model,Beijing China finance Press.
Wolf,H.,2001,”exchange rate regime choice and consequences”,NBER Working paper,October 2001.
Liu aiwen
Though Krugman’s target zone theory of exchange rate possess attractive policy implication,the model is rejected from presumption to conclusion in empirical study.The paper retransform the Krugman’s model with dividing layer and set up monitoring indicators,which leads to a lot of predominate performance;however,the new model need some other matching macroeconomic policy and perfection of market institutions in order to exert its functions.At first,the paper briefly introduce Krugman’s standard target zone of exchange rate,then retransform the model according to the inability of reality,and elaborate the the new model’s mechanism, policy implication and matching policies in detail;finally,the paper explore exit arrangement and future trend of current RMB exchange rate regime;conclusinonly,the paper think that double-layer monitoring model of exchange rate target zone will be desirable choice of RMB exchange rate regime for a long time.
Key words:target zone of exchange rate, equilibrium exchange rate,honeymoon effect,monetary shock,real shock.
1. Introduction
International exchange rate regime historical evolution show that both free floating exchange rate regime and hard fixed exchange rate regime all possess advantages and disadvantages. scholars that argue for hard fixed exchange rate only emphasize on the convenience which its nominal anchor function act on invest and trade, while those experts that support free floating exchange regime strengthen on the local monetary policy independence to which the free floating exchange rate regime leads to some extent. so there are the debate of so-called fixed and floating.However,decision-maker of all countries are afraid of turbulent free floating exchange rate regime between two world war and long-time real exchange rate misalignment which hard fixed exchange rate regime leads to under Bretton Woods system. They try to integrate the advantages of the fixed and floating exchange rate regime and build a exchange rate regime property of stability and flexibility, which is target zone of exchange rate.ERM March in 1979 was usually viewed as the exemplification of target zone theory of exchange rate.
The paper which follows begins in section 2 with a briefly introduction to Krugman’s target zone of exchange rate.Section 3 provides Double-layer monitoring model of exchange rate target zone.Section 4 provides 4. Supporting policies of the new model.Section 5 elaborates on the necessity and steps of implementing the new model.Section 6 provides a brief conclusion.
2. Briefly introducte to Krugman’s target zone of exchange rate
The earlist explorer to exchange rate target zone in theory is Williamsons,but Krugman put forward the strict theoretical model of standard exchange rate target zone in 1991(see graph 1).Krugman assume that exchange rate rely on current basic elements and future exchange rate expection,meanwhile,Krugman’s model still have two key assumptions,the first is that exchange rate target zone is completely credible,which means that its upper and lower limit will keep fixed;the second is that the exchange rate target zone safe guard by marginally intervention,namely monetary authority intervene only if the exchange rate move to the upper and lower limit of the regime,so there are on intervention in target zone.under the assumptions, exchange rate in target zone moving paths show “S” shape(see graph 1),from the graph 1,we can find that fluctuation range of curve TT (exchange rate behaviors of target zone) is obviously less than that of line FF(exchange rate behaviors of free floating regime),which means that completely credible exchange rate target zone have intrinsic stability mechanism. However the Krugman model assumptions of completely credible and marginal intervention have been rejected by empirical data（Flood et al，1991）.moreover, Obstfeld,M. and Rogoff,K also think that the model will confront the same problems as fixed exchange rate regime when exchange rate move toward the boundary of target zone（Obstfeld,M. and Rogoff,K.,1995）.based on those shortcoming of Krugman’s model,author transform it correspondingly,which is the following double-layer monitoring model of exchange rate target zone（see graph 2）.
3. Double-layer monitoring model of exchange rate target zone
3.1 design points
Considering that superiority and infeasibility in practice of Krugman’s model,we transformed it and divided fluctuation range into two layer,the fires layer is free floating band, namely S0～S1 range of graph 2,which government don’t intervene exchange rate movements;the second layer is monitoring intervention band,which band width is half of that of free floating band,namely S0～S'0 and S'1～S'1 of graph 2,government monitor the exchange rate move based on monitoring indicators;dashed line S0 and S1 is soft intervention line and government made it unknown to the public,if exchange rate move toward the S0 or S1,the probability of government intervention is very low;dashed line S'0 and S'1 is hard intervention line and government made it known to the public,if exchange rate reached the one of two lines,the probability of the government intervention is very high;finally,central exchange rate will adjust according to 1/2ΔB,which make the new target zone and original target zone overlapped.。
3.2 mechanism
Monitoring indicators of target zone includes exchange rate,interest rate,rate of inflation and duration time,through monitoring the status of indicators,we can distinguish between monetary shocks and real shocks,which determine central bank operate sterilized intervention or not or adjust the central exchange rate.when exchange rate stay in the monitoring band and interest rate surpass the monitoring indicator for a long time,it shows monetary shock,so central bank should operate sterilized intervention and central exchange rate should keep fixed;accordingly,when exchange rate stay in the monitoring band and the rate of inflation exceed the monitoring indicator for a long time,it indicates real shock and misalignment of exchange rate,so the central exchange rate should adjust with 1/2ΔB;when exchange rate stay in the monitoring band,meanwhile interest rate and the rate of inflation exceed the monitoring indicators,which measure should be adopted depend upon loss function of the central bank. through above analysis,we can find that automatic alignment function is peculiar to double-layer monitoring model of exchange rate target zone,which avoid exchange rate misalignment and stabilize the demand of invest and trade and achieve foreign economic in china. Moreover, the new model require that we must strengthen the fiscal discipline and implement the prudent fiscal and monetary policy and decrease the central bank ability for fiscal deficit.
3.3 policy implications
Exchange rate target zone model of double-layer monitoring possess those conventional favorite of krugman’s model honeymoon effect and decreasing the exchange rate fluctuation through dividing layer and setting up monitoring index,besides those above,it also has several benefits,as follows,at first,through setting free floating band,central bank needn’t intervene the exchange rate in zone,so more independence are endowed to monetary policy and central bank also behave against the economic circumstance according to the own economic cycle;secondly,because the width of exchange rate fluctuation is large than zero,central bank acquire the independence of monetary policy,meanwhile, the nominal anchor of exchange rate disappear to some extent,so speculative capital lose the attacking the target,which debase the speculative capital single side’s betting action;thirdly,for the width of target intervention zone is half of the width of free floating zone,if the based exchange rate readjust,the new exchange rate target zone is overlapped with the original exchange rate target zone,which avoid the leaping of exchange rate;finally,foreign exchange resource allocation become more effective,because exchange rate is determined by the supply and demand of foreign exchange market,it is well known that equilibrium exchange rate determined by market satisfy the principle of marginal cost amounting to the marginal revenue.
In a word, the new model design is accordance with gradual opening up of finance market in China. with the improving of Chinese economy,the width of free floating band will enlarge until fully free floating.
4. Supporting policies
In order that the new model normally operate,we must perfect the supporting policies.exchange rate policy,which is only a part of macroeconomic policies,must coordinate with other macroeconomic policies,so the predetermined policy goal can be reached.now we elaborate on the supporting policies related to the the new model from the following aspects.
4.1 Strengthening the regional currency cooperation
In a world with economy globalization accelerated,no country can be a refuge island during the storm of finance crisis and asia financial crisis in 1997 is an illustrative example.the crisis also impels that Asian countries and regions recognize the importance and urgency of the region currency cooperation.in a two-countries theoretical model of exchange rate, if two countries hold together to defend against the speculative attacks,the probability of successful safeguard is very high.perfecting operation of the model rely on coordination and cooperation of region currency policy,so we should strengthen currency cooperation of other asian country and establish the international coordination mechanisms so as to incorporated withstand the speculative attacks.at present,asian currency cooperation acquire initial fruits,in 1999,Mahathir,Malasian Prime Minister,put forward the suggestion of setting up “east Asia currency fund” and therefore promote the agreement on the “Chiang Mai Initiative” signed by 10 countries ASEAN plus China,Japan and Korea in May 2000,namely 10+3,which decide to enlarge the range of participation countries.at present,a series of bilateral money swap agreements have been signed among 10+3 countries.moreover,the cooperation formation,to utilize swap and buy-back to urgently aid to crisis countries,make of the asia currency cooperation institute foundation in reality. East asia economy all have amounts of foreign exchange reserve,by the end of 2007,there are 1530 billions foreign exchange in China,973.37 billions in Japan,262.22 bilions in Korea,270.3 billions in Taiwan region and 152.7 billions in Hongkong region,so these provide stability foundation for the new model implementing.
4.2 Reforming institutions of hampering production factors to flow,so forming internal dynamical mechanism of economic development.
The advantages of the new model is automatic alignment to equilibrium exchange rate;however,the precondition of the function is that market exchange rate fluctuate around the equilibrium exchange rate and these market, including monetary market,capital market and commodity market, can smoothly clear out. at present,China still have some structural probles and a lot of institutes which influence resources rational allocation still exist, which run counter to the intrinsic requirement of market economy.so,on one hand we need do our best to strengthen infrastructure construction, perfect the soft resources configuration,such as management and logistic, so as to eliminate the basic barriers; on the other hand we should reform the institutes hindering factors freely flow,for example,to impel RMB interest rate market reform,the reasons are that interest rate control easily lead to the problems of adverse selection and moral hazard,which form financial constraints and financial repression;moreover,economic agent throw themselves into rent-seeking incentively,which make resource allocation distorted and decrease social welfare.so RMB interest rate market lay a perfect foundation for RMB forward transactions,future transactions and avoiding exchange risk of Chinese enterprise,so as to perfect the RMB exchange rate forming regime; we still abolish the institute of hindering labor force to free flow,for example household registration system.by virtue of property right system reform, we can establish the mechanisms of state-owned enterprise and state-owned financial institues,so as to solve high risk and low efficiency of theirs;we also establish and perfect the self-employed system,which is the fundamental task of economy reform,in fact,self-employed system is not only increment reform,,but also it is the most important step which is overall orient-market economy reform and form intrinsic dynamic mechanism of economic development,meanwhile,it is the the best compensate and final entrance of poverty alleviation policy.
4.3 Perfecting forming mechanism of RMB exchange rate
Current RMB exchange rate forming is up to currency authority will,so its market foundation is very weak.as a result,in order that the new model operate boundly,we must cultivate mature and diversified market agent,develop diversified product,perfect the foreign exchange transaction mode and improve the exchange rate forming mechanism and so on.therefore,firstly we should release the condition of market access and cultivate mature and diversified market agent;secondly we must increase the kinds of market transaction,including several aspects,increasing kinds of foreign exchange transaction,developing RMB forward and future markets to avoid financial risk;thirdly wu should perfect the transaction mode of foreign exchange, that is to say,China should preferentially develop commercial bank’s market-maker system and popularize large number agency transaction.which may activate foreign exchange market and make exchange rate to reflect the expectation of market participant and make the price message function more remarkable;finally we should improve the RMB forming mechanisms and transform compulsory exchange surrendering system into a willing one,so as to clear the foreign exchange market out efficiency and form equilibrium exchange rate.
4.4 Reinforcing market supervision
For exchange rate regime don’t substitute for prudential supervision for financial system,Operation of the new model also rely on effective market supervision.reality of east asian financial crisis have proved that, in the global times, lacking of effective supervision and disordering liberalization would present international speculator the opportunity of making waves so as to amplify the original risk of financial system;moreover herding effect triggered by exterior speculator spread over domestic investors,which make capital market heavily distorted so as to cause hardly controlling financial crisis.so,in order to operate of the new model normally,firstly we seriously monitor the domestic balance sheet to avoid heavily mismatching of currency and maturity.secondly we need perfect the monitoring system,improve monitoring early-warning system,increase the supervision efficiency and control the market risk;thirdly we must vigorously reconstruct and normalize the foreign exchange market order,promptly grasp and precisely analysis the situation of foreign exchange fund flowing in and the trend of international balance of payment,severely strike all kinds of illegal foreign exchange transactions and illegal across border fund flow so as to prevent short-term speculative capital from swarming into our country;finally,we must improve the coordination mechanism of market supervision department.
5. The necessity and steps of implementing the new model
As a rapid developed emerging market economy, our country’s economic structure characteristic of Dualism Economy in urban and rural areas is comparatively obvious;meanwhile,after entering into WTO,China will confront complex economic shocks, not only including either interior or exterior shocks, but also including either monetary or real impacts; so these require that exchange rate regime both act as nominal anchor function and keep independent of monetary policy so as to adopt the complex economic situation,which is incompetent for current hard dollar pegged system.the new model,to some extent,both undertake nominal anchor function of exchange rate and keep monetary policy independent,meanwhile,the new model also possess automatic-alignment of equilibrium exchange rate,which is vital for Chinese exchange rate regime reform.of course,reform of RMB exchange rate regime must be impelled step by step,which means that the process of RMB exchange rate regime transforming into more flexible system also must follow certain steps.
5.1 Converting de facto single peg to dollar regime into peg to currency basket regime
Chinese foreign trade and invest increasingly diversified,for example,in 2003, total foreign trade value of major economy with China account for Chinese foreign trade value as following:American is 14.8 per cent;EU is 14.7 per cent;Japan is 15.7 per cent;Hongkong is 10.3 per cent;Asean is 9.2 per cent;Korea is 7.4 per cent. Single dollar pegged system only stabilize the bilateral nominal exchange rate of China and American,however,dollar,yen and euro are independent floating, so the system usually make RMB nominal trade weight exchange rate (nominal effective exchange rate) fluctuated, which aren’t favor to stabilizing the development of our country foreign trade and invest.so,in order to stabilize RMB real effective exchange rate,RMB must peg to a basket of currency,as for the currency selection in basket,we may select Chinese major trade partner currency and currency weight is proportion to their trade ratio according to ABC rule.
5.2 Broadening the range of fluctuation,while implementing exchange rate target zone model of double-layer monitoring
As a developing giant,China’s economic cycle hardly keep synchronization with other countries,which require monetary independence in China;however,China can’t implement completely free floating regime in view of imperfection of Chinese financial market.under this situations,we must increase flexibility of RMB exchange rate,on one hand we must broaden the RMB exchange rate floating range,on the other hand we must set upper and lower limit of exchange rate fluctuation in order to limit its excessive volatility,from this view,Chian should implement double-layer monitoring exchange rate target zone mechanism. considering real exchange rate volatility situations from 1994,the new model’s free floating band should adopt plus or minus 5 per cent and monitoring band should adopt plus or minus 2.5 per cent.in view of special situations in China,such as remarkable differential in regions and the structure characteristic of dualism economy,so the main goal of China’s monetary policy reach interior equilibrium,in turn,the rate of inflation should be adopted as the monitoring indicator.such arrangement guarantee both flexibility of exchange rate adjusting and stabilization of exchange rate fluctuation,which is in accord with the mode of China’s reform step by step.
5.3 Propelling capital account convertibility,thus realizing RMB free floating
At present, free convertible in current-account has been realized in China,but the foreign transaction in capital-account was still strictly regulated. in theory, foreign exchange regulation only have short-term insulating effect but can’t guarantee effectively the development of one country’s economy and finance for a long time.as a member of WTO,we must open the financial fields all-round,that is say,China’s economy will be influenced by global economy cycle to some extent.so we must reform financial management system accordingly so as to adapt to the new international situations.in the long run,capital account regulation isn’t a effective means,which isn’t favor of utilization of two resource and two market for China’s economy and hinder domestic resource effective allocating among international range,so we should eliminate the capital regulation step by step and accordingly establish sound,scientific and modern financial management system.according to the development trend of China’s economy,China is able to support RMB freely convertible and realize RMB single polar leaping,viz,free floating exchange rate regime,which means the market system establishment in China ultimately.
5.4 Implementing RMB internationalization
To realize RMB from free convertibility to free floating isn’t our final goal,which is phased goal at most.in reality,free convertible currency are a lot in the world,for example,theirs currency,such as Bulgaria, Estonia in east European and Latin America countries,are all convertible,but their currency was absent treatment for their economic power. Carlos’s empirical test indicates that currency free convertibility isn’t correlate to the economic growth (Carlos Arteta et al.，2001).so our monetary policy goal should be RMB internationalization.RMB become world currency,which promote international influence of China and RMB discourse rights,avoid risk of currency and maturity mismatching and increase seigniorage revenue for China. Above those is the necessity of RMB internationalization, sustainable development of our economy lay firm foundation for RMB internationalization; moreover, increasable maturity of China’s financial market and improvement of financial institution present reliable regulation guarantee for RMB internationalization.
6.Conclusion
After entering into WTO,china will face all kinds of economic impacts,including internal impact and external shock as well as currency impact and real shock. Double-layer monitoring model make honeymoon effect of target zone reappearing;what is more,its model is a self-stabilizing system. in the near and far future,the double-layer monitoring model of exchange rate target zone will be a desirable choice of RMB exchange rate system, moreover,it may act as the bridge smoothly leading to free floating exchange rate regime.
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