Yan, Isabel K. and Kakkar, Vikas (2010): The equilibrium real exchange rate of China: a productivity approach. Forthcoming in: China and Asia in the Global Economy
Download (298kB) | Preview
A large body of theoretical and empirical works asserts that exchange rates depend upon a country's productivity growth, and this effect is dubbed the Balassa-Samuelson effect. This paper examines the evidence for a Balassa-Samuelson based explanation for the real exchange rate movements of China vis-a-vis the U.S. dollar. Using disaggregated industry level data, we construct sectoral total factor productivities (TFPs) for the tradable and nontradable sectors from 1980-2003. Our main findings are: (a) the sectoral TFP differential is cointegrated with the relative price of nontradables with the unit cointegration vector; and (b) the real exchange rate is cointegrated with home and foreign sectoral TFP differentials. This productivity based real exchange rate model is then used to estimate the equilibrium exchange rates of the Renminbi (RMB). A comparison of the equilibrium exchange rate predicted by the productivity-based model and the actual rate indicates that the Renminbi is somewhat undervalued against the US dollar, though the undervaluation is not statistically significant. Our conclusions continue to hold even after we have controlled for the movements of net foreign assets.
|Item Type:||MPRA Paper|
|Original Title:||The equilibrium real exchange rate of China: a productivity approach|
|Keywords:||Nontraded Goods; Balassa-Samuelson Model; Cointegration|
|Subjects:||F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
F - International Economics > F3 - International Finance > F31 - Foreign Exchange
|Depositing User:||Isabel Yan|
|Date Deposited:||06. Dec 2011 14:00|
|Last Modified:||13. Feb 2013 09:21|
Amsler, C. and Lee, J. (1995), “An LM Test For A Unit Root In The Presence of a Structural Change”, Econometric Theory, 11, pp. 359-368.
Baak, S. (2008), “The Bilateral Real Exchange Rates and Trade Between China and the U.S.”, China Economic Review, 19, pp. 117-127.
Balassa, B (1964), “The Purchasing-Power Parity Doctrine: A Reappraisal”, Journal of Political Economy, 51, pp. 584-596.
Bennett, J. and Dixon, H.D. (2001), “Monetary Policy and Credit in China: A Theoretical Analysis”, Journal of Macroeconomics, 23(1), pp.297-314.
CEIC database, CEIC Data Company Ltd. http://www.ceicdata.com/
Chang, G. H. and Shao, Q. (2004), “How Much is the Chinese Currency Undervalued? A Quantitative Estimation”, China Economic Review, 15, pp. 366-371.
Cheung, Y., Chinn, M. and Fujii, E. (2007), “The Overvaluation of Renminbi Undervaluation”, Journal of International Money and Finance, 26, pp. 762-785.
China Statistical Yearbook, National Bureau of Statistics of China, China Statistics Press.
Chinn, M. (2000), “The Usual Suspects: Productivity and Demand Shocks and Asia-Pacific Real Exchange Rate”, Review of International Economics, 8(1), pp. 20-43.
Chinn, M. (2005), “A Primer on Real Effective Exchange Rates: Determinants, Overvaluation, Trade Flows and Competitive Devaluation”, NBER Working Paper 11521, July 2005.
Chow, G. C. (1993), “Capital Formation and Economic Growth in China”, The Quarterly Journal of Economics, 108(3), pp. 809-842.
Chow, G. C. (2002), China's Economic Transformation, Blackwell Publishing.
Chow, G. C. (2006), “New Capital Estimates for China: Comments”, China Economic Review, 17, pp. 186-192.
Chow, G. C. and Li, K. W. (2002), “China's Economic Growth: 1952-2010”, Economic Development and Cultural Change, 51(1), pp. 247-256.
Clarida, R. and Gali, J. (1994), “Sources of Real Exchange Rate Movements: How Important Are Nominal Shocks”, Carnegie-Rochester Conference Series on Public Policy, 41, pp. 1-56.
Coudert, V. and Cecile C. (2007), “Real Equilibrium Exchange Rate in China is the Renminbi Undervalued”, Journal of Asian Economics, 18, pp. 568-594.
Edwards, S. (1988), Exchange rate misalignment in developing countries, Baltimore: Johns Hopkins University Press.
Égert, B., Lommatzsch, K. and Halpern, L. (2006), "Equilibrium Exchange Rates in Central and Eastern Europe: A Meta-Regression Analysis", Journal of Banking and Finance, 30(5), pp. 1359-1374.
Égert, B., Lommatzsch, K. and Lahrèche-Révil, A. (2006), "Real Exchange Rates in Small Open OECD and Transition Economies: Comparing Apples with Oranges?", Journal of Banking and Finance, 30(12), pp. 3393-3406.
Eichenbaum, M. and Evans, C. (1995), “Some Empirical Evidence on the Effects of Monetary Policy Shocks on Exchange Rates”, Quarterly Journal of Economics, 110(4), pp. 975-1009.
Frankel, J. (2004), “On the Renminbi: The Choice Between Adjustment Under a Fixed Exchange Rate and Adjustment Under a Flexible Rate”, paper written for a High-Level Seminar on Foreign Exchange System, held in Dalian, China, May 26-27, 2004.
Feenstra, C. R. and Kee, H. L. (2004), “On the Measurement of Product Variety in Trade”, American Economic Review, 94(2), pp.145-149.
Funke, M. and Rahn, J. (2005), “Just How Undervalued is the Chinese Renminbi”, The World Economy, 28(4), pp.465-489.
Gagnon, J. E. (1996), "Net Foreign Assets and Equilibrium Exchange Rates: Panel Evidence", International Finance Discussion Paper No. 574, Board of Governors of the Federal Reserve System.
Gavin, M. (1991), "Terms of Trade, the Trade Balance, and Stability: The Role of Savings Behavior", International Finance Discussion Papers No. 397, Board of Governors of the Federal Reserve System.
Gregory, A.W. and Hansen B.E. (1996), “Residual-based Tests for Cointegration in Models with Regime Shifts”, Journal of Econometrics 70, pp. 99-126.
Holz, C. A. (2006), “New Capital Estimates for China”, China Economic Review, 17, pp. 142-185.
Holz, C. A. (2006). Measuring Chinese Productivity Growth, 1952-2005, manuscript.
Hooper, P. and Morton, J. (1982), "Fluctuations in the Dollar: A Model of Nominal and Real Exchange Rate Determination", Journal of International Money and Finance, 1, pp. 39-56.
Hu, F. Z. and Khan, M. S. (1997), “Why Is China Growing So Fast?”, International Monetary Fund Staff Papers, 44(1), pp.103-31.
Hua, P. (2007), “Real Exchange Rate and Manufacturing Employment in China”, China Economic Review, 18, pp. 335-353.
Huang, H. and Wang S. (2004), “Exchange Rate Regimes: China's Experience and Choices”, China Economic Review, 15, pp. 336-342.
International Financial Statistics (IFS) database, International Monetary Fund (IMF).
Ito, T., Isard, P. and Symansky, S. (1996), "Economic Growth and Real Exchange Rate: An Overview of the Balassa-Samuelson Hypothesis in Asia," In: Takatoshi Ito and Anne O. Krueger Eds., Changes in Exchange Rates in Rates in Rapidly Developing Countries, NBER-East Asia Seminar on Economics Volume 7, pp. 109-128.
Kakkar, V. (2002), “Capital-Labor Ratios and Total Factor Productivity in the Balassa-Samuelson Model”, Review of International Economics, 10(1), pp. 166-176.
Kim, J. I. and Lau, J. L. (1995), “The role of human Capital in the economic growth of the East Asian newly industrialized countries”, Asia-Pacific Economic Review, 1(3), pp. 3-22.
Lane, P.M. and Milesi-Ferretti, G. M. (2002),"External Wealth, the Trade Balance, and the Real Exchange Rate", European Economic Review, 46(6), pp. 1046-1071.
Lane, P.M. and Milesi-Ferretti, G. M. (2004), "The Transfer Problem Revisited: Net Foreign Assets and Real Exchange Rates", Review of Economics and Statistics, 86(4), pp. 841-857.
Lane, P.M. and Milesi-Ferretti, G. M. (2006), "The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004", Institute for International Integration Studies Discussion Paper No. 126., Trinity College, The University of Dublin.
Li, K. Wai. (2002), “Hong Kong's Productivity and Competitiveness in the Two Decades of 1980-2000”, manuscript, City University of Hong Kong.
Molodtsova, T., Nikolsko-Rzhevskyy, A. and Papell, D. H. (2007), “Taylor Rules with Real Time Data: A Tale of Two Countries and One Exchange Rate”, presented at the Conference on John Taylor's Contributions to Monetary Theory and Policy held at the Federal Reserve Bank of Dallas, October 12, 2007.
Obstfeld, M. and Kenneth R. (1996), Foundations of International Macroeconomics, The MIT Press, Cambridge, Massachussets.
Park, J. Y. (1990), “Testing for Unit Roots and Cointegration by Variable Addition”, Advances in Econometrics, 8, pp. 107-133.
Park, J. Y. (1992), “Canonical Cointegrating Regressions”, Econometrica, 60, 1992, pp. 119-43.
Park, J. Y. and Choi, I. (1988), “A New Approach to Testing for a Unit Root”, Working Paper no. 88-23. Ithaca, N.Y. Cornell University, Center for Analytic Economics.
Park, J. Y. and Ogaki, M. (1991), “Inference in Cointegrated Models Using VAR Prewhitening to Estimate Shortrun Dynamics”, Rochester Center for Economic Research Working Paper No. 281, University of Rochester, Rochester, NY.
Park, J. Y. and Phillips, P.C.B. (1988), “Statistical Inference in Regressions with Integrated Processes: Part 1”, Econometric Theory, 5, pp. 468-498.
Phillips, P. C. B. and Perron, P. (1988), “Testing a Unit Root in Time Series Regression”, Biometrika, 75, pp. 335-46.
Rogoff, K. (1992), “Traded Goods Consumption Smoothing and the Random Walk Behavior of the Real Exchange Rate”, NBER Working Papers No. 4119, National Bureau of Economic Research, Inc.
Said, S. E. and Dickey, D. A. (1984), “Testing for Unit Roots in Autoregressive-Moving Average Models of Unknown Order”, Biometrika, 71, pp. 599-607.
Samuelson, P. (1964), “Theoretical Notes on Trade Problems” Review of Economics and Statistics, 46, pp. 145-54.
Schmidt and Phillips (1992), “LM Tests for a Unit Root In The Presence of Deterministic Trends” Oxford Bulletin of Economics and Statistics, 54(3), pp. 257-287.
Wang, T. (2005), “Sources of Real Exchange Rate Fluctuations in China”, Journal of Comparative Economics, 33, pp. 753-771.
Zhang, Z. (2001), “Real Exchange Rate Misalignment in China: An Empirical Investigation”, Journal of Comparative Economics, 29, pp. 80-94.
Zhong, G. G., Nei, S., Chan, Z. Z., He, S. S. (1997), (in Chinese), 中国国家统计局国民经济核算司, 中国国内生产总值核算历史资料, 东北财经大学出版社.