Equilibrium and Misalignment: An Assessment of the RMB Exchange Rate from 1978 to 1999

Exchange rate misalignment tends to disrupt the economic growth of developing countries, and persistent overvaluation may even lead to currency crises. Since the Asian financial crises in 1998, economists and policy makers have been concerned with whether or not the China currency, renminbi yuan (RMB) is overvalued. Based on new developments in the equilibrium exchange rate theory, this paper develops equilibrium real exchange rate (ERER) and behavioral equilibrium exchange rate (BEER) models for RMB by using cointegration analysis, the Hodrick-Prescott (H-P) filter and other econometrics techniques. The estimation results show that the exchange rate of RMB is close to the equilibrium level in 1999. Towards the end, this paper analyzes the trajectory of RMB exchange rate misalignment since 1978, and makes an assessment of RMB exchange rates. The author suggests gradual reforms in exchange rate policies.