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The renminbi equilibrium exchange rate: an agnostic view

The supposed undervaluation of the renminbi has been the subject of intensive academic research over the past few years. Using equilibrium exchange rate models (Purchasing Power Parity, BEER and FEER), many authors have concluded that the renminbi is undervalued by 15 to 30% against the dollar. This article shows that the common view is not that obvious. The models used in the estimation (BEER or FEER) assume that the economy is at full-employment, a strong hypothesis for developing economies such as China, whose unemployed amount to 150 million people. On the contrary, we show that China is facing massive unemployment and if investment depends on expected potential demand (from domestic consumption and foreign demand), then an undervalued exchange rate (by traditional standards) is suited for its policy objectives. Therefore the exchange rate can be analyzed as a policy tool used by the Chinese authorities to pursue their objectives. The exchange rate can be undervalued by traditional standards and in equilibrium compared to the government's policy objectives. This article shows that equilibrium exchange rate theories are not suited for developing countries and therefore the concept of equilibrium exchange rate is highly questionable. The final section analyzes the adoption of a managed float regime by the Popular Bank of China and discusses the delicate issue of the best exchange rate regime for China.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2006-13.

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Date of creation: 2006
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Handle: RePEc:fce:doctra:0613
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  18. Antoine Bouveret & Henri Sterdyniak, 2005. "Les modèles de taux de change. Équilibre de long terme, dynamique et hystérèse," Revue de l'OFCE, Presses de Sciences-Po, vol. 93(2), pages 243-286.
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  21. Ronald McKinnon, 2005. "Exchange Rate or Wage Changes in International Adjustment? Japan and China versus the United States," Discussion Papers 04-021, Stanford Institute for Economic Policy Research.
  22. Ronald I. McKinnon, 2005. "Exchange rates, wages, and international adjustment: Japan and China versus the United States," Proceedings, Federal Reserve Bank of San Francisco, issue Feb.
  23. Dominique Desruelle & Alessandro Zanello, 1997. "A Primeron the IMF's Information Notice System," IMF Working Papers 97/71, International Monetary Fund.
  24. Hanen Gharbi, 2005. "La gestion des taux de change dans les pays émergents. La leçon des expériences récentes," Revue de l'OFCE, Presses de Sciences-Po, vol. 95(4), pages 279-326.
  25. Hanen Gharbi,, 2005. "La gestion des taux de change dans les pays émergents: la leçon des expériences récentes," Documents de Travail de l'OFCE 2005-06, Observatoire Francais des Conjonctures Economiques (OFCE).
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