Yin-Wong Cheung, Eiji Fujii and I have just completed a paper entitled China's Current Account and Exchange Rate" for a conference on China's Growing Role in World Trade. This paper follows up on some of the issues I laid out in these posts: [1], [2], [3], and [4].
Figure 1: China's Current Account in billions of USD (blue, left scale) and Current Account to GDP ratio (red, right scale). 2006 and 2007 data are estimates and projections. Source: IMF, World Economic Outlook, April 2007 database.
We obtain several interesting results. First, the CNY is substantially below the value predicted by our cross country estimates. The economic magnitude of the mis-alignment is substantial – on the order of 50% in log terms. However, we also find that the misalignment is typically not statistically significant, in the sense of being more than one standard error away from the conditional mean.
Second, we find that Chinese multilateral trade flows do respond to relative prices -- as represented by a trade weighted exchange rate -- but that that relationship is not always precisely estimated. In addition, the direction of effects is different than expected a priori. For instance, we find that Chinese ordinary imports rise in response to a yuan depreciation. However, Chinese exports do appear to respond to yuan depreciation in the expected manner, as long as a supply variable is included. So, in this sense, Chinese trade is not exceptional.
Furthermore, Chinese trade with the U.S. appears to behave in a standard manner -- especially after the expansion in the Chinese manufacturing capital stock is accounted for. Thus, the China-US trade balance should respond to real exchange rate and relative income movements in the anticipated manner. However, in neither the case of multilateral or bilateral trade flows should one expect quantitatively large effects arising from exchange rate changes.
