Empirical Testing of Exchange Rate and Interest Rate Transmission Channels in China

Abstract

This paper examines the exchange rate and interest rate volatility transmission channels in China by applying Granger causality, Johansen cointegration, and the VAR model. Empirical results taken from the exchange rate channel favor the exchange rate and the Shanghai composite index return volatility pass-through in imports and exports; those taken from the interest rate channel favor the deposit and lending rates as well as the Shanghai composite index return volatility pass-through in PPI. Our empirical evidence supports the presence of exchange rate and interest rate transmission channels in China. By manipulating the exchange rate and through its monetary policy, the China government can cool down the country’s overheating economy.