Currency Substitution, Monetary Independence, and Real Exchange Rate Dynamics

An increase in the importance of RMB (Renminbi, the Chinese currency) in Taiwanese’s portfolio along with the expectation of increased RMB volatility and loosened capital control in China due to admission to the SDR (Special Drawing Right) currency club complicates the physical environment faced by Taiwan. In particular, whether the RMB and the US dollar exhibit complementarity or substitutability should be taken into account in evaluating the effectiveness and independence of the CBC’s (the Central Bank of the Republic of China (Taiwan)) monetary policy. In addition, the dynamic adjustment path of relevant macroeconomic variables such as real exchange rate is examined with consideration of currency substitution. We construct a dynamic general equilibrium model with currency substitution to study these issues