1. China’s Current Account and Exchange Rate Yin-Wong CHEUNG, UCSC & HKU Menzie D. CHINN, UW-Madison & NBER Eiji FUJII, University of Tsukuba NBER Conference “China’s Growing Role in World Trade” August 3, 2007

2. China’s Current Account Source: IMF, World Economic Outlook April 2007 database

3. The Value of CNY Source: IMF, International Financial Statistics, author’s calculations

4. Trade Balance and Forex Reserves Source: IMF, International Financial Statistics

5. Outline An analysis of the CNY misalignment issue using the standard deviations-from- Absolute PPP approach Highlighting the tension between economic and statistical significance Closer look at elasticities from a macro perspective The importance of uncertainty arises again Exchange rate is important but not central

6. Evaluating the Exchange Rate

7. Exploiting the “Penn Effect” Data from World Development Indicators, 1971-2005 Vintages of WDI matter (the China path is substantially different than our previous paper) The r is in PPP terms, the y in USD, PPP terms

8. The “Penn Effect” Estimated

9. The “Penn Effect” Illustrated (I)

10. The “Penn Effect” Illustrated (II)

11. Observations The 2005 CNY is about 1.5 standard errors from conditional mean, so statistically not misaligned But the point estimate indicates a 50% (!) undervaluation (in log terms) If one changes the definition of undervaluation as (e.g.) 3 consecutive years of misalignment, not much changes since ρ ≈ 0.95

12. Investigating China’s Trade Elasticities

13. Multilateral Trade Elasticities Standard static imperfect substitutes approach. Analysis conducted on quarterly frequency, over 1993-06 period. Sample period largely dictated by data availability (changes in data collection). y, y* are real GDP, q is CPI deflated, z is supply variable, w additional demand factor

14. Chinese Exports

15. Two (Recurring) Problems Chinese export data don’t match rest-of- world import data, vice versa No Chinese deflators, pre-2005 We rely on the Chinese data for multilateral exports, imports We try various proxies as deflators

16. Proxies for Export Deflators

19. Observations Holding z constant results in really high income elasticity estimates, wrong sign on exchange rate. For aggregate exports, only z matters. For ordinary exports, income is insignificant, while others come in significantly Processing and parts exports fit quite well All results sensitive to inclusion of trend

20. Chinese Imports

21. Proxies for Import Deflators

23. Some Observations Aggregate, ordinary imports have wrong signed price elasticities Processing and parts imports only slightly better behaved

24. Alternative Import Specification Since others have suggested a link between parts imports and exports, we include total exports, w This yields more intuitive estimates for the exchange rate elasticity

25. Implications for Policy (I) Multilateral basis, 10% appreciation leads to A decline of imports by 70 bn A rise in the TB of 15 bn Zeroing out the perverse elasticity leads to a decline in the TB of 46 bn 2006 TB was 956 bn (2000$) ( < $86 bn in Marquez-Schindler) A decline of exports by 25 bn (2000$)

26. Bilateral Trade Elasticities The standard equation augmented with a trade weighted ex-U.S. real exchange rate variable The q is now CNY/USD (CPI deflated) We examine both Chinese and US measures of China-US trade

27. Chinese Exports to U.S.

28. What Accounts for the Differences? For Chinese exports, Chinese record as f.o.b., US reports as c.i.f. Chinese goods transiting HK might or might not be correctly attributed to China Value added in HK might be improperly attributed to China (see e.g., Schindler and Beckett, 2006)

29. Proxies for Chinese-U.S. Export Deflators

30. CNY/USD Real Exchange Rate Note: “Adjusted” indicates nominal exchange rate takes into account transactions taking place at floating rate.

31. Chinese Bilateral Export Elasticities

32. Chinese Imports from U.S.

33. Proxies for Chinese-U.S. Import Deflators

34. Chinese Bilateral Import Elasticities

35. Implications for Policy (II) A 10% real appreciation of CNY/USD results in 33 bn (2000$) reduction in trade balance The 2006 China-US trade balance was 229 bn (2000) No necessary implication for overall US trade deficit

36. Next Tasks Formal calculation of misalignment probabilities Checking for sensitivity to additional regressors Alternative measures of rest-of-world GDP (export weighted GDP, world imports)