Urban Jermann, Bin Wei, and Vivian Yue of the Federal Reserve Bank of Atlanta
The foreign exchange rate is the rate at which one currency can be exchanged for another and, as such, it is an important determinant of the price of imports and exports.
As China is one of the world’s largest importers and exporters, the exchange rate for its currency, the renminbi or RMB, is not only important to the Chinese but also to the global economy. Additionally, the RMB exchange rate and especially trends in that rate can have important consequences for capital flows (the movement of money between countries), which is an especially important consideration for the financial system of developing countries such as China.
There are a wide variety of exchange rate policies a country can follow. At one extreme, the currency can be allowed to float, with its value being set in foreign exchange markets. At the other extreme, the exchange can be fixed with regard to some other asset or bundle of assets (typically, some other foreign currency).
On July 21, 2005, China depegged its currency from the U.S. dollar and followed a “managed floating” exchange rate policy that allows the RMB to move toward its market rate but at a controlled pace.