Does a correlation exist between the foreign exchange reserves and the exchange rate? : An empirical study of China

Abstract: The main purpose of this study is to investigate relationship between foreign exchange reserves and RMB exchange rate. In order to obtain a precise result, foreign trade situation and GDP are also considered. The monthly data is collected over period 1994 to 2011, and processed through ADF test, Johansen test, and Granger causality test. Final results indicate that there is a long-term equilibrium relationship existing between foreign exchange reserves and RMB exchange rate. Moreover, any changes of foreign exchange reserves would lead to the fluctuation of RMB exchange rate but not vice versa. At last, the dummy variables are added into regression model to test influence from the reform of RMB exchange rate regime. Results suggest that regime reform not only increase flexibility of RMB exchange rate, but also slow down the accumulation of foreign exchange reserves.