The Two-Pillar Policy for the RMB

Urban J. Jermann, Bin Wei, and Vivian Z. Yue
Working Paper 2019-08
April 2019

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We document stylized facts about China's recent exchange rate policy for its currency, the renminbi (RMB). Our empirical findings suggest that a "two-pillar policy" is in place, aiming to balance RMB index stability and exchange rate flexibility. We then develop a tractable no-arbitrage model of the RMB under the two-pillar policy. Using derivatives data on the RMB and the U.S. dollar index, we estimate the model to assess financial markets' views about the fundamental exchange rate and sustainability of the policy. Our model is able to predict the modification of the two-pillar policy in May 2017, when a discretion-based "countercyclical factor" was introduced for the first time. We also examine the model's ability to forecast RMB movements.

JEL classification: F31, G12, G13, G15

Key words: exchange rate policy, two-pillar policy, managed float, Chinese currency, renminbi, RMB, central parity, RMB index

For helpful comments and suggestions, the authors thank Markus Brunnermeier, Mario Crucini, Wenxin Du (discussant), Mark Spiegel (discussant), Stijn Van Nieuwerburgh, Larry Wall, Wei Xiong, Tao Zha, and participants at the Atlanta Fed, the Federal Reserve Board, the University of Western Ontario, Tsinghua University, the first IMF-Atlanta Fed Workshop on China's Economy, 2019 American Finance Association meetings, and the Bank of Canada-University of Toronto China conference. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Urban J. Jermann, Finance Department, The Wharton School, University of Pennsylvania and NBER, 3620 Locust Walk, Philadelphia, PA 19104-6367, 215-898-4184,; Bin Wei, Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404 498 8913,; or Vivian Z. Yue, Economics Department, Emory University, the Federal Reserve Bank of Atlanta, and NBER, 602 Fishburne Drive, Atlanta, GA 30322, 646-961-8274,
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