International pressure to revalue China’s currency stems in part from the expectation that rapid economic growth should be associated with a real exchange rate appreciation. This hinges on the Balassa-Samuelson hypothesis under which economic growth, stemming from improvements in traded sector productivity, causes non-traded prices to rise. The puzzle is that, while evidence on China’s productivity and prices supports this hypothesis, its real exchange rate has shown no long run tendency to appreciate. Resolution requires extension of the hypothesis to allow for effects on the real exchange rate due to non-traded productivity improvements or, in association with failures of the law of one price for traded goods, labour supply growth and growth-related demand switches due to changes in financial capital flows and trade distortions. The sensitivity of China’s real exchange rate to these determinants is reviewed with the results confirming that financial and capital outflows are dominant depreciating forces in the short run. Along with WTO accession trade reforms, it is shown that the heretofore rising surplus of Chinese domestic saving over its investment has restrained the real exchange rate from appreciating since the late 1990s.
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Paper provided by Australian National University, Centre for Applied Macroeconomic Analysis in its series CAMA Working Papers with number
2007-14.
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Find related papers by JEL classification: C68 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Computable General Equilibrium Models C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications E27 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Forecasting and Simulation F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation O11 - Economic Development, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
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