The Two-Pillar Policy for the RMB

Abstract

This paper studies China's recent exchange rate policy for the renminbi (RMB). We demonstrate empirically that a two-pillar policy is in place, aiming to balance exchange rate flexibility and RMB index stability viamarketandbasketpillars. We further extend and validate the formulation that incorporates the so-called countercyclical factor. Theoretically, we develop a flexible-price monetary model for the RMB in which the two-pillar policy arises endogenously as an optimal response of the government. We estimate the model by generalized method of moments and quantitatively assess various policy trade-offs.