The Time-Varying Causal Relationship Between International Capital Flows and the Real Effective Exchange Rate: New Evidence for China

Abstract

We test the bilateral causal relationship between four types of international capital flows and the real effective exchange rate (REER) in China over the period 1998:Q1 to 2016:Q2 and examine whether the link is time varying. Parameter stability tests suggest that the relationship between capital flows and the RMB REER is time varying both in the short and the long run. Bootstrap rolling-window causality tests suggest bidirectional Granger causal relationships between the current account, portfolio investments and FDI, and the REER in several sub-periods, and a Granger-causal relationship from foreign exchange reserves to the REER in some sub-periods.