Relationshipbetween RMB Exchange Rate and China-US Trade Balance

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 Abstract

51education | 01.23.2015

   

    The trend of RMBexchange rate and expectation of appreciation have become the internationalfocus point. It has been shown that there is an increasing pressure on RMBappreciation from the U.S and other western countries. As a result, theexpectation for appreciation of RMB has been increased further. Since July,2005, the reform of RMB exchange rate, it has been shown that the appreciationof RMB has increased more than 30%. Added to this, the RMB appreciation isunilateral appreciation. Up to December, 2013, the exchange rate of RMB to USdollar is 6.1024 RMB/U$. From the long run perspective, there is still pressurefor RMB appreciation.

 

    According to theclassical theory of international payments, only if import and export trade ofa country meet 'Marshall-Lerner' conditions,currency appreciation would make its trade balance worse. On the other hand,depreciation can improve its trade balance. However,based on the retrospection of RMB exchange rate system evolution process andthe course of trade balance development between China and US, this thesis foundthat at most of the time, the RMB exchange rate appreciation to the UnitedStates did not make China's huge surplus improved dramatically.

 

    This dissertation describes in detail the domestic and foreign scholars’ empiricalresearch on this issue in the past few decades. Then this dissertation reviewsthe history of RMB exchange rate policy since 1949 and statistically describesChinese trade balance under the guidance of different exchange rate policy. Apreliminary conclusion can be got: RMB exchange rate changes have limitedimpact on trade balance and other factors besides the exchange rate influencethe trade balance more apparently.

 

    Next, theelasticity analysis method and absorption analysis method have been combined,drawing on the theoretical model of McKinnon to discuss different effects ofthe exchange rate on the trade balance in a closed economy and open economy. Ina closed economy, if the Marshall-lerner condition holds, currency devaluationcan indeed improve the trade balance; in an open economic environment in whichinterest rate parity holds, currency depreciation will lead to the rise of thedomestic price levels simultaneously. Then real interest rate decreases as thenominal interest rate keeps unchanged which has to be the same with the worldinterest rate. It will greatly promote the growth of domestic investment, andultimately the increase of the value of domestic absorption surpasses theincrease of national income. Currency devaluation does not necessarily improvea country’s trade balance.

 

    Accordingly, thedissertation can be concluded: RMB exchange rate does not assume primaryresponsibility for the China-US trade imbalance and the RMB appreciation willnot eas the trade imbalance as well. The US should review its own policies forthe key to solve the problem. Finally, this dissertation puts forward somerecommendations for policy makers to refer to, including accelerating RMBexchange rate reform, rationalizing China’s export product structure andimporting more from certain countries.

 

    Keywords: theRMB appreciation expectations, bilateral trade between China and the USA,Johansen co integration test, Marshall-Lerner Condition, Impulse responsefunction

 

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