Testing the Purchasing Power Parity of Chinese Renminbi(RMB)

This paper tests validity of the purchasing power parity (PPP)hypothesis for estimation and determination of the RMB/USD exchange, which is based on the monthly data of RMB/USD nominal exchange rate, Chinese Consumer Price Index (CPI) and the U.S. CPI from May 1994 to December 2006. The empirical results show that the variation of RMB/Dollar exchange rate has a tendency of reverting to the PPP level, which supports a long-run PPP relationship of RMB/Dollar exchange rate. In other words, the validity of the PPP for estimating and determination of the long run equilibrium RMB/USD exchange rate is verified. But we find the regression equation isn't fitted well to that of the real fluctuation of RMB/Dollar exchange rate, which indicates the short-run deviation of RMB/Dollar exchange rate from the PPP equilibrium exchange rate. We argue that short-run impact of other macroeconomic variables may cause the real exchange rate of RMB to deviate from the PPP equilibrium one. We then propose some approaches of modifying PPP econometric model when applying it for estimating RMB long-run equilibrium value or judging whether RMB real exchange rate is at its appropriate level.