Examining the Relationship Between Trade Balance and Exchange Rate: the Case of China's Trade with the Usa

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This PDF is a selection from a published volume from the National Bureau of Economic Research
Volume Title: China's Growing Role in World Trade
Volume Author/Editor: Robert C. Feenstra and Shang-Jin Wei, editors Volume Publisher: University of Chicago Press
Volume ISBN: 0-226-23971-3
Volume URL: http://www.nber.org/books/feen07-1
Conference Date: August 3-4, 2007
Publication Date: March 2010
Chapter Title: China's Current Account and Exchange Rate
Chapter Author: Yin-Wong Cheung, Menzie D. Chinn, Eiji Fujii Chapter URL: http://www.nber.org/chapters/c10461
Chapter pages in book: (231 - 271)

7
China’s Current Account and
Exchange Rate
Yin-Wong Cheung, Menzie D. Chinn, and Eiji Fujii

7.1

Introduction

China—and Chinese economic policy—has loomed large on the global economic stage in recent years. Yet, even as arguments over the normalcy of the Chinese trade balance and the value of the Chinese currency continue, there is substantial debate in both academic and policy circles surrounding what the determinants of these variables are.

Interestingly, there are very few studies that simultaneously assess the Chinese exchange rate and trade/current account balance. This is partly an outcome of the peculiar characteristics of the Chinese economy. In this study, we attempt to inform the debate over the interactions between the exchange rate and the current account by recourse to two key methodologies. First, we identify the equilibrium real exchange rate from the standpoint of cross-country studies. Second, we attempt to obtain more precise estimates of Chinese trade elasticities, both on a multilateral and bilateral (with the United States) basis. In doing so, we hope to transcend the current limited debate based upon rules of thumb.

Yin-Wong Cheung is a professor of economics at the University of California, Santa Cruz, and a guest professor of economics at the Shandong University. Menzie D. Chinn is professor of public affairs and economics at the Robert M. La Follette School of Public Affairs and the Department of Economics, University of Wisconsin, and a research associate of the National Bureau of Economic Research. Eiji Fujii is a professor of economics at the Graduate School of Systems and Information Engineering, University of Tsukuba. We thank the discussant Jeffrey Frankel, Shang-Jin Wei, Arthur Kroeber, Xiangming Li, Jaime Marquez, and conference participants for comments and discussion; and Kenneth Chow, Guillaume Gaulier, Chang-Tai Hsieh and Hiro Ito for providing data. Cheung acknowledges the hospitality of the Hong Kong Institute for Monetary Research, where part of this research was conducted. Faculty research funds of the University of California, Santa Cruz, the University of Wisconsin, and Grants-in-Aid for Scientific Research are gratefully acknowledged.

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Yin-Wong Cheung, Menzie D. Chinn, and Eiji Fujii

To anticipate our results, we obtain several interesting findings. First, the renminbi (RMB) was substantially below the value predicted by our crosscountry estimates (although that conclusion does not survive the advent of revised data). The economic magnitude of the misalignment is substantial— on the order of 50 percent in log terms. However, we also find that the misalignment is typically not statistically significant, in the sense of being more than 1 standard error away from the conditional mean. Moreover, substantial revisions to the underlying data provide even more reason to be circumspect about estimates of currency misalignment.

Second, we find that Chinese multilateral trade flows do respond to relative prices—as represented by a trade-weighted exchange rate—but that that relationship is not always precisely estimated. In addition, the direction of effects is different than expected a priori. For instance, we find that Chinese ordinary imports rise in response to a RMB depreciation. However, Chinese exports do appear to respond to RMB depreciation in the expected...
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