Modeling the Effect of Exchange Rate Liberalization on China’s Macro Economy

Abstract

The empirical characteristics of domestic and foreign interest rate shocks are obtained by using VAR method: the domestic interest rate regulation is counter-cyclical, and the increase of foreign interest rate leads to the increase of domestic output and inflation. On this basis, we construct a small open dynamic stochastic general equilibrium theory framework which reflects the empirical characteristics, including exchange rate control, to analyze the macroeconomic effects of exchange rate liberalization reform. By volatility simulation, impulse response and social welfare loss function analysis, the empirical results show that: firstly, exchange rate reform would increase volatility of output and exchange rate, but reduce volatility of inflation and interest rate. Secondly, exchange rate reform enhances the impact of domestic interest rate shocks on output and inflation. Which means the reform would improve the control ability of interest rate as a monetary policy tool. Moreover, the reform increases loss of social welfare. The conclusion shows that the exchange rate liberalization should be implemented step by step. The government should accelerate the reform when the external macro economy is stable. Otherwise it will cause a larger economic volatility.

An Improved Long Short-Term Memory Neural Network for Macroeconomic Forecast

“…In recent years, China has witnessed rapid economic growth and continued improvement of market economic system. To ensure the rapid, stable, and healthy development of the economy, the policymakers need to understand the laws and features of the market economy, and make major economic decisions in line with these laws [1][2][3].…”