i. Currency mismatch and economic growth: Razin and Collins (1997) indicate that the exchange rate mismatch, i.e. the exchange rate deviation from PPP, occurs in both developing and developed countries but only the serious overestimation affects economic growth. Generally, exchange rates are moderately underestimated in countries with rapid economic growth. Thus, PPP test is an extremely important tool to monitor policy makers and ensure economic growth. In the late 1990s, the Asian financial crisis caused great damage to the Asian countries and even the world’s economy. Meanwhile, people have the chance to see the critical negative outcome of exchange rate overvaluation and inappropriate exchange rate regime and monetary policy errors. During the Asian financial crisis, China also suffered a shock. To stabilize the world’s economy, China has promised not to devalue the RMB, that actually caused the overestimation of Yuan, and that in turn caused the damage directly on Chinese import and export trade that year. And after year 2003, the appreciation of Chinese Yuan is also facing strong pressure. But whether the Yuan is undervalued or overvalued in the end is a highly debated factor. Therefore, the empirical study of purchasing power parity of RMB has very practical significances, mainly in determining the nominal exchange rate anchor or whether there is a serious mismatch, maintaining sustained and stable growth of China’s economy, and providing protections for the improvement of China’s exchange rate system.
Thus, regardless of other developing countries, or China itself, the empirical test of purchasing power parity theory has great significances: it is not only a country’s policy maker in deciding the choice of exchange rate regime and a powerful tool to determine the form of monetary union, but also provides a standard to compare levels of development between countries. Test purchasing power parity is also important for forecasting the financial crisis and providing a reliable guide. In short, the purchasing power parity tests play an important role in different areas of the economy. It is certain that, as the economic and financial environment changes, the continuous inspection for purchasing power parity is necessary, and in the future it will not stop.