The RMB value added real effective exchange rate: Theory, measurement and analysis

This paper enhances the theoretical framework of the value-added real effective exchange rate by integrating factor market theory, leading to the development of a general equilibrium-based value-added real effective exchange rate model. Utilizing this framework, the study attempts to construct a potential value-added real effective exchange rate for the Renminbi by endogenously addressing the value-added price index and the actual final use. The resulting potential value-added real effective exchange rate for the Renminbi is compared and analyzed from the perspectives of weights, price indices, and substitution elasticities. The findings indicate that the endogenous treatment of the value-added price index significantly influences the cumulative changes in the potential value-added real effective exchange rate of the Renminbi. Additionally, the endogenous processing of actual final use enables an exploration of the input linkages and relative output gaps between China and its partner countries and regions, which arise from differences in weights. Variations in substitution elasticities similarly affect both weight discrepancies and the overall fluctuations in the real effective exchange rate. Furthermore, exogenic shocks that affect labor demand serve as the main drivers of changes in the potential value-added real effective exchange rate. By examining the Renminbi's potential value-added real effective exchange rate, this study provides valuable insights into the relationship between China's initiatives to boost domestic demand and advance supply-side reforms, serving as a reference point for market-oriented factor price reforms.