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China’s Equilibrium Real Exchange Rate: A Counterfactual Analysis

  • Rod Tyers

    ()

  • Yongxiang Bu
  • Ian Bain

    ()

China’s maintenance of a de facto peg against the US dollar during and following the Asian financial crisis caused a realignment of exchange rates in the Asian region. This paper explores the “equilibrium” level of China’s real effective rate in the lead-up to, during and following that crisis. An adaptation of the Devarajan-Lewis-Robinson three-good general equilibrium model is employed to estimate time paths of the equilibrium real effective exchange rate under a variety of assumptions about the balance of trade. Key requirements of the model are indices of import and export prices in time series. Since these are unavailable from secondary sources they are here constructed from trade data. The results suggest that, while there is no clear evidence of undervaluation as of 2004, China’s real effective exchange rate was on the low side in the lead-up to and during the crisis, due in part to an extraordinary rate of accumulation of foreign reserves and an associated trade surplus following the integration of its hitherto multiple exchange rates in 1994. If, instead, China had run a more typical trade deficit, say amounting to 10 per cent of export revenue or 1.5 per cent of GDP, it is estimated that China’s real effective exchange rate would have been higher by about a tenth prior to the crisis.

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File URL: http://cbe.anu.edu.au/researchpapers/econ/wp466.pdf
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Paper provided by Australian National University, College of Business and Economics, School of Economics in its series ANU Working Papers in Economics and Econometrics with number 2006-466.

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Length: 29 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:acb:cbeeco:2006-466
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  1. Rod Tyers & Yongzheng Yang, 2000. "Weathering the Asian Crisis: The Role of China," Asia Pacific Economic Papers 308, Australia-Japan Research Centre, Crawford School of Public Policy, The Australian National University.
  2. John Whalley & Xian Xin, 2006. "China's FDI and Non-FDI Economies and the Sustainability of Future High Chinese Growth," NBER Working Papers 12249, National Bureau of Economic Research, Inc.
  3. Eswar Prasad & Shang-Jin Wei, 2007. "The Chinese Approach to Capital Inflows: Patterns and Possible Explanations," NBER Chapters, in: Capital Controls and Capital Flows in Emerging Economies: Policies, Practices and Consequences, pages 421-480 National Bureau of Economic Research, Inc.
  4. Michael P. Dooley & David Folkerts-Landau & Peter Garber, 2007. "Direct Investment, Rising Real Wages and the Absorption of Excess Labor in the Periphery," NBER Chapters, in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 103-132 National Bureau of Economic Research, Inc.
  5. Wei, Shang-Jin & Zeckhauser, Richard J., 1998. "Two crises and two Chinas," Japan and the World Economy, Elsevier, vol. 10(3), pages 359-369, July.
  6. Yin-Wong Cheung & Menzie D. Chinn & Eiji Fujii, 2005. "Why the renminbi might be overvalued (but probably isn’t)," Proceedings, Federal Reserve Bank of San Francisco.
  7. Takatoshi Ito & Kathryn M. Dominguez & Moeen Qureshi & Zhang Shengman & Masaru Yoshitomi, 1999. "Capital Flows to East Asia," NBER Chapters, in: International Capital Flows, pages 111-190 National Bureau of Economic Research, Inc.
  8. Sebastian Edwards, 1989. "Real Exchange Rates in the Developing Countries: Concepts and Measure- ment," NBER Working Papers 2950, National Bureau of Economic Research, Inc.
  9. Chou, W. L. & Shih, Y. C., 1998. "The Equilibrium Exchange Rate of the Chinese Renminbi," Journal of Comparative Economics, Elsevier, vol. 26(1), pages 165-174, March.
  10. John G. Fernald & Oliver D. Babson, 1999. "Why has China survived the Asian crisis so well? What risks remain?," International Finance Discussion Papers 633, Board of Governors of the Federal Reserve System (U.S.).
  11. Chinn, Menzie D. & Ito, Hiro, 2007. "Current account balances, financial development and institutions: Assaying the world "saving glut"," Journal of International Money and Finance, Elsevier, vol. 26(4), pages 546-569, June.
  12. Ivan Roberts & Rod Tyers, 2003. "China's Exchange Rate Policy: The Case for Greater Flexibility," Asian Economic Journal, East Asian Economic Association, vol. 17(2), pages 155-184, 06.
  13. Corden, W Max, 1993. "Exchange Rate Policies for Developing Countries," Economic Journal, Royal Economic Society, vol. 103(416), pages 198-207, January.
  14. Yongzheng Yang & Rod Tyers, 2001. "The Asian Crisis and Economic Change in China," The Japanese Economic Review, Japanese Economic Association, vol. 52(4), pages 491-510.
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