With the ever-increasing and emergence of international trade, exchange rate behavior plays an integral role in policymaking and determinations about global financial analysis as well as the market environment that different states will be engaged in. This paper analyses the degree of Renminbi, RMB's misalignment by calculating the exchange rate at which one currency is traded against the RMB in this case. In this paper, the Chines currency RMB movement compared to other world currencies like the U.S. dollar, euros, among others. China is an open economy that has moved to export more than imports; it has undertaken policy decisions to remain competitive and realize its economic growth among world developed economies.
An exchange rate refers to the rate at which one currency is traded against the other, which the ever increasing to cater for inflationary effects that continue to affect the international trade currency values. The benchmark about the currency exchange rate is at equilibrium compared to another country, mainly the USD. The nominal exchange is given by the equation as; Ee = E (Pf /Pd), where, E is the domestic price that can be used to acquire a given some of foreign currencies like the euro or U.S. Dollar, Pf and Pd refer to the price indices for both international and domestic relating to the goods that are under the purchase and sell agreement.
Internal exchange arte refers to the ratio of domestic price of goods in a domestic market environment that are sold to the goods in the same local market that are not sold to foreign economies or exported and it is given by Ei = internal price of sellable goods/domestic [price of the non-tradable goods. The research is based in China; hence, the analysis will mainly be concerned by the approaches Chines economy uses to stabilize their currency with regard to other world currencies by mainly making the RMB flexible rather than being pegged to a US Dollar that discourages international trade since it is not flexible even during the hardest world economic times. Johansen co-integration techniques may also be used in the analysis. The BEER approach is mainly used to explain the variability of the exchange rates in the world economies as to what price should one currency be used to purchase another and the underlying conditions that cause the relative changes in exchange rates. Exchange rate policy has become a significant issue concerning since China became an open economy by encouraging its exports to multinational states across the world (Cheung, Chow, & Qin, 2017).
The Chines exchange rate policies have emerged as a point of contention with other nations such as the USA in the recent past due to China pegging of RMB to USD. The international monetary fund, IMF, passed a decision to include the RMB into the individual drawing right, helping China enter the global financial system, which increased China's foreign exchange and economic growth. Different countries that trade with China have always complained of trade imbalances that is caused by pegging of the RMB to especially the US dollar since many significant countries use the US dollar as a standard currency for trading (MacDonald, & Clark, 1998). Economies as a result of the trade imbalances caused by the RMB peg, have tried to stabilize the exchange rate using the Purchase Price Parity approach.
The model has been largely argued that it is useful in establishing a common agreed exchange arte regime that favors all players that participate in international trade especially those trading within China since it is China that pegged its RMB affecting other world currencies. Ronald McDonalds and Peter B. Clark introduced the BEER method countries that are undertaking international trade have had an issue on currency exchange among them as they advocate for a slightly steady exchange rate to avoid both realized and unrealized exchange differences in their accounting records. China needs to initiate measures and policies to stabilize their exchange rates to encourage other states to do business with it since other different nations have an accused China for its attitude and policy directions of appreciating its RMB and other currencies that have also been an issue in the recent past that have always viewed China's policies as being implemented to initiate unfair competition in the international financial institutions mainly.
Different nations have argues that Chines currency policies are that are focused on making exports less costly or cheaper, but making its imports expensive through the control of the RMB policies as compared to when the RMB was allowed to trade freely. It started to peg its RMB back in 1994 through 2005 at the rate of 8.28 RMB per dollar as the base currency (1USD=8.28RMB's) (Cheung, Chow, & Qin, 2017). It is until 2005, when most states tried to avoid trading with China, which they moved their RMB to a managed peg system that allowed it to flex based on the available different economic situations that resulted in harmonize the economy of money in world markets.
Equilibrium exchange rate has been an issue discussed among major world financial partners in international trade. Over the past decades, there has been a rise in Chinese economic growth. The equilibrium exchange rate affects the country's competitiveness. In order to achieve and establish a trade balance, a stable and more flexible exchange rate is highly considered a noble move to promote trade among different states with China, otherwise, if not properly managed, and it would negatively affect the stable condition of the economy of the industry resulting in the global financial disaster. The model assesses the extent of real exchange rate adjustment suitable to move the country's external imbalances to an appropriate level.
Increased exports have led to China's economic growth as its exports are cheap compared to imports. The policies formulated and implemented by the Chines government on foreign trade have promoted more exports than imports hence economic growth. Its exports have outpaced imports. For example, in 2001, it exported goods and services worth $266.6 billion, accounting for about 4% of the world exports in the same year (Cheung, Chow, & Qin, 2017). The pegging of the RMB against the USD has maintained a stable currency in line with China's log run economic interests different financial institutions such as banks have formulated and advised for RMB to switch from a strictly dollar-peg to a basket of currencies such as euro, sterling pound, Canadian dollar, and USD.
Open macroeconomics has postulated the equilibrium exchange rate as a common determinant factor in international trade involving currency exchanges, and it measures of purchasing power parity model (Song, & Woo, 2008). The LOOP ascertains that similar items or goods will fetch or have the same amount. Still, the market segments are different, causing the prices to be converted into a single denomination for uniformity and comparison purposes. In the process, most economists have tried to establish as to whether the RMB is undervalued or over-valued in order to advice the strategies that should be used to restore any unbalancing effect that is caused by exchange arte movement with the aim of ensuring g that the economy y is stable for trading for both Chia and other countries. In this case, the discussion will be mainly concentrated on the BEER model.
THE BEER approach BEER方法
The BEER model was founded and proposed by McDonald and in 1998 and it is not a normative model like others, such as the FEER model. It is used to establish and analyze different behaviors of exchanges rates, and it tries to mainly establish a stable exchange rate used by world economies as a common means of trading (MacDonald, & Clark, 1998). The BEER Model establishes causes of change and the frequent shift of the exchange rates. The BEER approach has always been compared to others like FEER to establish as to whether the main object of the model is in line with the economic fundamentals upon which the model was built. It compares the misalignment that have always existed and brought about by peg of the RMB to the US Dollar.
China’s economy has criticized the BEER model for producing lower RMB estimates than the FEER model. According to the model, in 2003, the RMB was just 5% undervalued and 3% undervalued in 2003. It is used in the estimation and calculation of exchange rate values. It will also overcome the disadvantages that the FEER model is associated with. It has been widely used in developing nations to establish the exchange rate movements than in more industrialized economies such as the USA. According to the study that uses the BEER model, the RMB has not been undervalued consistently.
The BEER approach calculated the currency values given different determinants available to influence the number of foreign transactions. It has been used by economists in currency exchange analysis and the behavior of exchange rates among nations especially that undertake partnership in trading. It assesses the current value of the exchange rate and the statistical notion of equilibrium (Song, & Woo, 2008). It ascertains the actual behavior of the exchange rate based on the relevant explanatory regression equation that is in a reduced form is used to describe currency exchange movement pattern over a sample period.
Uncovered interest parity condition is used to establish the BEER by linking they currency rate and its associated interest at home and other world currencies. The BEER model is more practical as it involves the use of a reduced equation. Secondly, the approach is efficient and powerful in finding a stable exchange rate and other variables that affects the exchange movement (Iimi, 2006). Co-integartion analysis is used to establish the exchange rate that exit using the BEER approach especially for developing nations in order to [promote them to participate in international trade to avoid economic discrimination for less developed nations.
Nevertheless, the approach is important, useful, and suitable in developing nations since complex and large models are not feasible due to the quality and availability of data. Exchange rate equation is given as qt = β’1Z1t + β’2Z2t + τTt + εt ……………………………. (i) . The approach captures all fundamental and systematic movement of exchange rates and is subjected to rigorous statistical testing using different metrics like mean reversion speed. It is highly reliable model since it uses a single series of data to determine the exchange rate movement and it contains variables that have a direct effect on the exchange rate if simultaneously altered (Iimi, 2006). The equilibrium exchange rate is estimated by the sustainable values of the fundamentals that affect actual exchange rates in the end. The model is not subjected to the macroeconomic variables in the market surrounding, but on individual market elements that affect the exchange rate within the industry specific.
However, the model founder, Clark, and McDonald ascertain the current stable exchange rate would be explained where short and random terms from the above equation (i) are zero giving rise to a different equation as, qt = β’1Z1t + β’2Z2t …………………….. (ii).
Exchange misalignment is calculated as;
cmt + qt – q't = qt - β’1Z1t + β’2Z2t = τTt + εt ………………………………….. (iii), and total exchange misalignment is calculated as;
tmt = qt - β’1Z*1t - β’2Z*2t ……………………………..…………………… (iv)
Where Z*1t and Z*2t are the equilibrium variables that are fundamental in establishing the equilibrium. The interpretation of the Renminbi can also be interpreted as a percentage, which is defined using the equation as follows; Mis_RMB = ((qt –q't)/ (q't))*100% ….…………….. (v)
The BEER model starts from the UIP, which explains the short-run fluctuations for the exchange rates. Lack of the equilibrium state in the model can be corrected by the subjective analysis of the sustainable variables of the fundamentals analysis of the model in relation to exchange rates for international business operations, (Ma, Cheung, & 2011).
The approach is been used in analyzing currencies for developing countries through the addition of more commanding variables that could describe the structural changes for developing and small economic market segments. The model is shifted by explaining the real exchange rate movement among different currencies, and the equation is given by;
qit = f (Δ%TFPROD, TOT, GC/GDP, OPEN, CAPCON, s, qit – 1)…………..…………. (vi)
Where Δ%TFPROD, rate of growth of total factor productivity, G.C., refers to the consumption made by the government, OPEN is the trade policy proxy, CAPCON, severity of capital control, And GDP is a gross domestic product. The approach illustrates exchange rate movements in different transaction periods among different economies, and it differentiates different sources of the exchange rate misalignments.
To function properly, it has many different features that suit the equilibrium exchange rates for RMB and other currencies not forgetting the currencies for developing economies since they are to be integrated in the world economic development. It has a co-integration analysis as a valuable part of the model, which helps to achieve a stable common exchange rate among different nations’ currencies through the equation between the actual exchange rate and its economic important variables that are used to achieve the exchange rate stable condition.
The model assumes that other external factors affect changes of exchange rate for global business transaction such the RMB and USD changes that are market specific and on different occasions. The purchasing power parity is also another factor affecting the estimation of the exchange rates. The choice of the model was mainly caused by the following factors; First-time frames. The research was to be undertaken from the periods between 2000Q1 to 2004Q4, which is not long enough to allow for the microeconomic balance approaches used in estimating the real exchange rate (Iimi, 2006). It is suitable in the short run since China is experiencing a growing economy resulting from its increased exports and reduced importation, making the country gain from foreign direct investments and exchange rate shifts.
Secondly, the model is suitable as it includes real factors. It assumes that there are variables within the RMB that determines exchange rate movements. The model's design uses the real factor determinants to explain exchange rate movements within the business environment. Different variables affect the actual exchange rates and are summed together in a single equation expressed as Terms of Trade, TOT, Monetary Supply, M2, Commercial policy, OPEN, Technology progress, PROD, Control over capital flows, NFA, the ratio of investment, and government expenditures, GOV (Ma, Cheung, & 2011).
Finally, research interests promoted the establishment of the model. It is an important model in determining the stability of the exchange rate in the financial market environment by determining the RMB misalignment and understand the sources of various misalignments. Nevertheless, the model suffers from a significant milestone of limitations that includes the following; first, it has different measurements of productivity. Various approaches used in determining productivity include per capital CAPITA, the non-tradable goods approach, TNT that is determined by the ration of the CPI and the PPI. The ratio has been used within the proxy effects, such as tax changes and nominal exchange rates. Barriers to the free movement of labor pose restrictions among different sectors of the economy. The income per capita is used in the estimation of productivity, resulting in different results in the opinion of economic fundamentals from existing studies.
Again, the approach uses a short sample period since it uses data ranges from 2000 to 2011. The sample period is short; hence, it limits the use of the BEER model. The results yield may not be precise and entirely reliable for effective decision-making and drawing the economic findings (Song & Woo, (2008). Large sample sizes and more extended periods have been found to increase statistical precision in financial analysis. In this study, the sample period is the date from the period range, 2000 Quarter I to 2011 Quarter 4. The period is selected although short since there was no data available before 2000, but only post 2000 data was available.
The model lacks transition elements or variables in the short period available due to its flexible nature. It has different variables or factors that affect the economic exchange rate combined with variables that lead to exchange variations that assist in the split of the source of exchange rate misalignment (Ma, Cheung, & 2011). It focusses on determining the exchange rate and at the same time; transitory variables are ignored or assumed.
However, to mitigate the shortcomings of the BEER model, several fundamental have been proposed to improve the model. They include the combination of the dummy variable for a structural break. Dummy variable such as the global financial crisis has posed significant structural changes in the study to reflect the changes in the VAR model (Song, & Woo, (2008). The Renminbi was lightly undervalued when the global financial crisis occurred in 2008 that related to foreign demand, which disrupted many world economies, including China. A large sample or longer sample period allows in achieving a more reliable and effective data reliability. It increases data reliance and objectivity of the analysis within the financial sector of the economy. Other solutions to the disadvantages of the model include the use of different unit root test approach and involving an expanded set of explanatory variables. The model establishes the medium upon which the world exchange rate regimes should be traded in a fair, competitive environment to promote equality in international trade.
In conclusion, the model is suitable in exchange rate calculations and determinations with the aim of establishing a common source of discrepancies that cause major variations among international currencies. It should be recommended for use by developing economies, which have a shorter period with fewer data available for the analysis process. It should be integrated with other models such as the FEER approach, to determine the correct equilibrium exchange value for the RMBs among emerging world economies' currencies. The currencies in international trade should be allowed to trade freely without a peg for each country to enjoy exchange variances that arise due to frequent changes in the exchange by financial institutions because of both country's micro and macro-economic variables. Exchange stability can only be achieved via a stable and fair competing environment by both trading partners.
Iimi, A., & International Monetary Fund. (2006). Exchange rate misalignment: An application of the behavioral equilibrium exchange rate (BEER) to Botswana. Washington, D.C.?: International Monetary Fund.
Loukoianova, E., Iossifov, P., Loukoianova, E., & International Monetary Fund. (2007). Estimation of a Behavioral Equilibrium Exchange Rate Model for Ghana. Washington, D.C.: International Monetary Fund.
Ma, G., Cheung, Y.-W., & World Scientific (Firm). (2011). China and Asia in the global economy. Singapore: World Scientific Pub. Co.
MacDonald, R., Clark, P. B., MacDonald, R., & International Monetary Fund. (1998). Exchange Rates and Economic Fundamentals: A Methodological Comparison of Beers and Feers. Washington, D.C.: International Monetary Fund.
Sercu, P. (2011). International Finance: Theory into Practice. Princeton: Princeton University Press.
Cheung, Y.-W., Chow, K. K., & Qin, F. (2017). The RMB exchange rate: Past, current, and future.
Song, L., & Woo, W. T. (2008). China's dilemma: Economic growth, the environment, and climate change. Canberra: Anu E Press.