Question

1. On December 1^st (2015), IMF announced that the Chinese currency Renminbi (RMB, or Yuan) is included in the IMF assets -- Special Drawing Right (SDR), with 10.92% SDR weight, following U.S Dollar (41.73%) and Euro (30.93%), and ahead of Japanese Yen (8.33%), and the British Pound (8.09%).

This inclusion, in effect on Oct. 1^st, 2016, has suggested a new role of the Chinese currency and its economy in the global market. Conduct cost and benefit analysis and the potential economic impacts of Chinese RMB and the economy in this event.

Answer 1

There has been tremendous international political pressure on China, led mainly by the United States (US), to revalue its currency. The United States has argued that the competitive undervaluation of the Chinese Renminbi (RMB) and several neighboring Asian countries1has a substantial impact on the US economy (Bergsten 2010).

The Chinese economy has demonstrated remarkable capacity for growth in the past two decades. Gross domestic product (GDP) growth rates between 1998 and 2008 were consistently high and averaged 9.6 percent per year (World Bank 2009). Following the Balassa-Samuelson proposition, the consistently high GDP growth rate experienced by the Chinese economy should have been reflected in the path for the Chinese real ER.

Relative to those of other countries, such as India, Japan, Germany, and the United States, the Chinese current account balance as a percentage of GDP is positive, is persistently high, and has been steadily increasing since 2002, reaching 9.8 percent in 2008 (World Bank 2009). This is seen as a reflection of the undervaluation of the Chinese ER (Willenbockel 2006). Consistent with the Balassa-Samuelson expectation, a number of studies propose that the Chinese currency is undervalued by 15–41 percent (for example, Zhang and Pan 2004; Chang and Shao 2004; Chang 2008; Subramanian 2010; Goldstein and Lardy 2006; Cline and Williamson 2009; Frankel 2004; Goldstein 2004; Coudert and Couharde 2005)

The Chinese economy would shrink significantly as a result of RMB appreciation.e. As can be seen, most macroeconomic indicators respond negatively to the currency appreciation, excepting the real wage of labor and GDP deflator (decreased GDP deflator means reduced inflationary pressure). This holds for all three of the ER adjustment scenarios, with the impacts’ growing deeper with the rise in the degree of ER change. The setback in macroeconomic performance is of a wide spectrum, even for the 5 percent increase scenario, the smallest increment considered in the study. Specifically, when the nominal ER increases by 5 percent, the real GDP and total exports are estimated to decline by 3.1 percent and 3.5 percent, respectively. The GDP deflator declines by 3.4 percent, implying a 1.6 percent change of the real ER. Scenario results on changes in employment confirm the concerns raised by the Chinese government with the consideration of nominal wage rigidity (Zhang 2010; Wang and Zhao, 2007). Employment is expected to be hit hard, with a 6.3 percent reduction as a result of merely a 5 percent increase in the nominal ER. This is mainly because of the decline in demand for labor due to the rising real wage. Returns to capital, natural resources, and land also fall as economic activities decline. With labor demand going down, the ratio of capital to labor goes up, and the return to capital goes down. Consequently, investment drops by 2 percent.

Generally, as the Chinese ER increases, Chinese exports become more expensive, and the trade balance of other trading partner countries tends to improve. However, our results show that whereas this is generally true for the EU, Australia and New Zealand, the Association of Southeast Asian Nations, Japan and Korea, and the rest of the world, it is not the case for the United States. In fact, the trade balance of the United States is estimated to decrease by US$8.2 billion, US$15.4 billion, and US$22 billion under the scenarios of 5, 10, and 15 percent increases in Chinese ER, respectively

Results show that the overall US economy improves as a result of RMB appreciation. The real GDP increases by 0.7, 1.3, and 1.8 percent for Chinese ER increase of 5, 10, and 15 percent, respectively, under our short-run closure. This is translated to higher income and therefore higher imports relative to the baseline. Under the 5 percent ER increase scenario, for instance, whereas US exports increase by 0.2 percent, imports increase even more, by 0.5 percent, leading to a deteriorated trade balance. The higher imports are driven by higher demand by private consumption induced by rising income as well as higher demand for inputs required by the higher output. In regions other than the United States, imports will also increase with rising income, but the increases are never large enough to deteriorate the trade balance.

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