Academic journal article East Asian Economic Review

How Is the RMB Exchange Rate Misaligned? A Recent Application of Behavioral Equilibrium Exchange Rate (BEER) to China

Academic journal article East Asian Economic Review

How Is the RMB Exchange Rate Misaligned? A Recent Application of Behavioral Equilibrium Exchange Rate (BEER) to China

Article excerpt

(ProQuest: ... denotes formulae omitted.)

I. Introduction

Over the last several decades, we have witnessed that exchange rate policy has played an increasingly important role in the development of global economy. Diverse exchange rate regimes were applied by countries1. However, recent global financial crisis triggered lively discussions on "Currency War"2 which means that countries competitively devaluate their currencies so as to maintain their export competitiveness during the period of crisis. The latest example is Japan. Japanese yen has depreciated by more than 20 per cent since September 2012. It sparked concerns that other countries would follow Japan to devaluate their currencies to maintain international competitiveness3. But the Japanese authority argued that the sharp depreciation of yen is a market correction of overvalued yen over the past few years. The question arising from this debate is what the "appropriate" exchange rate of yen should be.

China is another example. Along with China's impressive performance in economic growth, Chinese currency, renminbi (also called yuan, henceforth, the RMB) exchange rate policy and the level of RMB exchange rates attracted intensive debates. China adopted managed floating exchange rate regime which indeed is to peg RMB to a single currency (the US dollar) or a currency basket4. Such exchange rate peg regime implies that the RMB's exchange rate needs to be "manipulated" so as to control excessive fluctuation of exchange rate. Not only China, but many economies do the similar thing on their currencies to different extents. Given China's economic size and trade share in the global economy, RMB exchange rates and the degree of its misalignment need to be carefully studied. More recently, it is widely believed that China's exchange rate policy significantly contributed to the global imbalance which might have led to 2007-2008 global financial crisis. Since July 2005, the RMB has appreciated by about 24 per cent in nominal term and 29 per cent in real term by the end of 2012. In addition, China's ratio of currency account surplus to GDP dropped considerably to 2.6 per cent in 2012 from 10.1 per cent in 2007. Chinese authority argued that the RMB is approaching to its equilibrium level and the RMB is no longer significantly undervalued. Naturally, we want to know if RMB exchange rate is approaching to an appropriate level and how the RMB is misaligned.

There are many discussions on the RMB exchange rate issues. Among them, estimation of the RMB's "equilibrium" exchange rate is one of the fundamental questions. This research attempts to find if the RMB is undervalued or overvalued. If so, how much is the RMB misaligned from its equilibrium exchange rate. It employs the Clark and Macdonald (1998)'s the Behavioral Equilibrium Exchange Rate (BEER) approach to assess the degree of RMB misalignment from its equilibrium exchange rate which is determined by economic fundamentals. In contrast to previous empirical studies which used yearly or quarterly data, this study applies monthly data to find more detailed information about the dynamics of RMB misalignment over the period. In addition, we add more economic fundamentals which could explain the behaviors of RMB exchange rate into the BEER model as explanatory variables.

The remainder of this paper is organized as follows. Section Two is literature review. And it briefly reviews recent developments of RMB exchange rate and explains what equilibrium exchange rate means in section Three. This is followed by section Four in which the data and analytical framework are explained. In section Five, the findings are presented and analyzed. Section Six concludes the paper.

II. Literature Review

RMB equilibrium exchange rates and RMB misalignment have been intensively studied by applying various methodologies. Empirical results by using the BEER approach from Zhang (2001) indicate that there was a dramatic fluctuation of RMB misalignment from 1955 to 2000. …

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