The Regime-Switching Policy for the RMB
56 Pages Posted: 28 Mar 2022 Last revised: 14 Aug 2023
Date Written: August 14, 2023
Abstract
The RMB exchange rate policy is governed by a two-pillar rule. This paper presents novel evidence of regime-switching in the policy coefficient on the market pillar, but not on the basket pillar. The switching is closely tied to the implementation of the counter-cyclical factor (CCF) policy, which is designed to address market irrationality. The frequency of regime-switching is significantly higher than what is officially announced, suggesting that the de facto policy differs from the de jure policy. Using a simple model, this paper demonstrates that the regime-switching policy has an expectation formation effect and allows the CCF policy to effectively prevent self-fulfilling depreciation and achieve its objective. Yet, the de jure CCF policy is unable to stabilize the RMB exchange market due to its weak expectation effect.
Keywords: Regime-switch, Exchange Rate, RMB Central Parity, Counter- cyclical Factor
JEL Classification: C13, C32, E58, F31
Suggested Citation: Suggested Citation