Tail Causality between Crude Oil Price and RMB Exchange Rate

• Author: Haoyuan Ding,Yuying Jin,Jiezhou Ying,Cong Qin
• Date: 01 May 2020
• DOI: http://doi.org/10.1111/cwe.12335
• Published date: 01 May 2020

©2020 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 116–134, Vol. 28, No. 3, 2020

116

*Haoyuan Ding, Associate Professor, College of Business and Shanghai Institute of International Finance and

Economics, Shanghai University of Finance and Economics, China. Email: dinghaoyuan@mail.shufe.edu.

cn; Yuying Jin (corresponding author), Professor, College of Business and Shanghai Institute of International

Finance and Economics, Shanghai University of Finance and Economics, China. Email: jyyshang@mail.

shufe.edu.cn; Cong Qin, Lecturer, National Academy of Development and Strategy, Renmin University of

China, China. Email: qincong@ruc.edu.cn; Jiezhou Ying, PhD Candidate, College of Business and Shanghai

Institute of International Finance and Economics, Shanghai University of Finance and Economics, China.

Email: 2016310097@live.sufe.edu.cn. The authors are grateful for fi nancial support from the National Natural

Science Foundation of China (No. 71703086), the National Social Science Fund of China (No. 18AZD010)

and the Program for Innovative Research Team of Shanghai University of Finance and Economics.

Tail Causality between Crude Oil Price

and RMB Exchange Rate

Haoyuan Ding, Yuying Jin, Cong Qin, Jiezhou Ying*

Abstract

In this paper we assess the causal relationship between international crude oil price

changes and the RMB exchange rate using daily information from 21 July 2005 to 5

April 2017. In addition to linear causality tests, we employ quantile causality test to

identify prior imperceptible causality in quantiles. We fi nd a causal relationship from

crude oil price to exchange rate at each quantile interval, but the reverse only appears

in tail. This may help to explain why a traditional linear test fails to capture the causality

from exchange rate to crude oil price as the quantile causalities in tails are canceled out

by each other. Moreover, using RMB as the settlement currency in crude oil trade can

weaken the prior signifi cant causal relationships between crude oil price and exchange

rate, whereas the reform of exchange rate marketization reignites the tail causalities

from exchange rate to crude oil price. These fi ndings recommend a wider use of domestic

currencies in crude oil trade to avoid risk from the crude oil market.

Key words: crude oil price, exchange rate, quantile causality test

JEL codes: C01, F31, F37

I. Introduction

The global fi nancial crisis triggered a worldwide rethink over the dominant role of the US

dollar in the international monetary system. The dominance of US dollar as the settlement

currency has been documented as a non-negligible factor of ensuing international fi nancial

Correction added on 26 June 2020, after initial online publication. A duplicate of this article was published under the

DOI 10.1111/cwe.12296. This duplicate has now been deleted and its DOI redirected to this version of the article.

©2020 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Crude Oil Price and RMB Exchange Rate 117

instability (Duncan, 2005).1 Despite the ongoing debate over this assertion, alternative

currencies are more favorably received in certain international markets. In the crude oil

market, an increasing number of countries have adopted RMB as an international crude-

oil-pricing currency. Since the end of 2014, Russia has used RMB as its settlement

currency in crude oil trade. In 2015, considering one-fifth of its annual crude oil

production shipped to China, Iran announced an RMB-denominated crude oil price. In

September 2017, Venezuela launched a basket of monetary systems and set RMB as the

pricing currency to settle international trade of crude oil and other products.2 Given the

emerging importance of RMB in the international crude oil market, using RMB as the

settlement currency may change the international monetary system and consequently the

relationship between the RMB/US$ exchange rate and crude oil price. This calls for a

careful exploration of the causality between crude oil price and RMB exchange rate.

In response to criticism of China’s regulated foreign exchange regime, the central

bank of China gave up pegging to the US dollar and in 2005 implemented a managed

float regime referring to a basket of foreign currencies. After the 2005 reform, RMB

became more fl exible and experienced a 20 percent appreciation to US dollar. To further

enhance the marketization and volatility of the RMB exchange rate, the central bank

launched another reform in 2015 aiming to promote RMB internationalization, thereby

providing a natural experiment that allows us to examine the impact of exchange rate

reform on the inter-causality between crude oil price and exchange rate.

Numerous studies have investigated how changes to international crude oil price

affect the exchange rate from a theoretical perspective. These studies can be roughly

classified into two categories. Krugman (1980, 1983) and Golub (1983) explained

the interaction through the balance of payments. Specifi cally, an increase in crude oil

price initially dampens the current account of importing countries and depreciates

their currency in the short run. Crude-oil-exporting countries (e.g. Organization of the

Petroleum Exporting Countries) then increase their goods imports and capital outfl ow

as their crude oil export surplus increases with the crude oil price. In the long run, the

capital outfl ows from crude-oil-exporting countries will offset the prior defi cit of crude-

oil-importing countries, and, finally, the currency of crude-oil-importing countries

will experience an appreciation. Amano and van Norden (1998) proposed another

1Duncan (2005) pointed out that the dollar standard system allows the US to fi nance extraordinarily large current

account defi cits by selling debt instruments to its trading partners. This practice can result in economic overheating

of asset prices in the US because its trading partners have reinvested their dollar surpluses in US$-dominated

assets. The dollar standard system also boosts credit creation in the US, causing businesses and families to fall into

excessive debt. These economic imbalances help drive US property prices to unsustainable levels.

2Please refer to Meng (2018) for more details.