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We use analytics cookies so we can keep track of the number of visitors to various parts of the site and understand how our website is used. For more information on how these cookies work please see our Cookie policy. Skip to main content. Back to top. Consequently, both must be taken into account in interpreting any exchange rate policy modification. Following this, this paper looks at the rationale behind the recent modification of the Chinese exchange rate policy in reviewing the two debates on the need for revaluation and greater flexibility.
The last section explores the short-run impact of this decision. This series of studies since was preceded by another series in the late s, which attempted to assess the sustainability of the peg to the dollar after the Asian financial crisis an overvaluation was then suspected.
As expected for a rapidly transforming economy, the estimated size of misalignment differs significantly across studies, and some estimations show almost perfectly reversed evolutions 4. The critical point is the diagnostic on the period: the current undervaluation is expected to be large narrow if one considers that the exchange rate was already undervalued near equilibrium in Let us start with the main arguments of a large undervaluation.
The first argument is trade dynamism. These basic features are systematically emphasised by foreign policy-makers. However, one can suggest that trade balances would be more relevant than exports and then recognise that Chinese imports also grew rapidly last year. Moreover, one can consider that the overall trade balance would be more relevant than bilateral trade balances, and then observe that a large part of the Chinese trade surplus with OECD countries is offset by trade deficits with Asian countries.
This situation is not common for an emerging economy, even more so when it regularly exhibits signs of overheating which increases demand for imports. The central bank had indeed to buy huge amounts of dollars that would have induced the exchange rate to appreciate under floatation. The weaker argument for a large undervaluation is the bilateral surplus with the United States since, as noted earlier, China runs large deficits with Asian countries. In fact, this particular structure of trade balances has been strongly induced by a structural change in the division of labour in East Asia, i.
This relocation has simultaneously raised imports from Asian countries and exports to OECD countries 6. This is illustrated in Table 2 reporting EU trade statistics for the first five months of , where it is clear that Chinese exports tend to replace the exports of other emerging economies. European Union Textiles and Clothing imports. An appreciation of the equilibrium Real Exchange Rate RER should come from relative productivity gains economic growth and reforms according to the Balassa-Samuelson effect.
It is reasonable to think that the productivity gain effect would be greater than the net effect of trade policy, but would not, under reasonable assumption, lead to a rapid and huge appreciation of the equilibrium RER 8.
High underemployment, as experienced by China, rather suggests a RER overvaluation according to internal equilibrium condition. Consequently, studies that focus only on the external condition simply overstate undervaluation 9. The exchange rate is not the instrument to be preferred against underemployment but a country that experiences high underemployment cannot, arguably, afford a massive revaluation. First, appreciation expectations were not dominant until November Moreover, being a developing country, China may reasonably keep a competitive cushion to manage external shocks.
But what should be expected from such a revaluation? Therefore, the reduction of trade imbalances is the main benefit to be expected from the revaluation.
However, such a result depends on the very nature of trade imbalances and on the value of trade price-elasticities. As noted earlier, exports dynamism is certainly explained as much by structural factors wage flexibility as by the exchange rate policy.
Moreover Chinese exports have a high import content due to the export-processing sector Therefore the China trade surplus is unlikely to be very sensitive to exchange rate fluctuations Unfortunately, export price-elasticity estimations based on recent data are scarce and heterogeneous Since these estimations cannot integrate the structural competitiveness of China, one could expect that the true elasticities are in fact smaller than estimated, or are non-linear an appreciation-induced drop in exports would be smaller than a depreciation-induced increase in exports.
Moreover, the reduction of imports volume would be fully offset by the increase in price with actually no effect on trade balance. In fact, any improvement in trade balance should then come from the expansion of OECD exports to China. According to Jonathan Anderson, even a large yuan revaluation would have a limited impact on the US trade deficit, which is more affected by trade competition with the European Union and Japan In the same vein, Ronald MacKinnon and Joseph Stiglitz point out that the USA will run current account deficit as long as US private and public savings are very low, whatever the Chinese exchange rate policy The fourth column is the average selling rate for Canadian Dollar.
The fifth column is the average selling rate for Deutsche Mark. The sixth column is the average selling rate for Swiss Franc. The seventh column is the average selling rate for Japanese Yen per The eighth column is the average selling rate for Australian Dollar.
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