| I study the effects of real depreciation on the trade balance and trade flows (import and export) between the US and China at the commodity level. I specifically test the presence of the J-Curve phenomenon, a major theory that predicts an initial deterioration and a delayed improvement of the trade balance in response to depreciation. Most previous studies that test the J-Curve theory, including studies on China, have produced mixed results. One of the potential reasons for this ambiguity is that previous work has employed trade data at the aggregate level and, therefore, may suffer from the aggregate bias problem. That is, a significant effect of depreciation on certain parts of the trade could be offset by an insignificant effect on the other parts. Measurement problems, which may be more prevalent with aggregate data, may also contribute to such ambiguity. In my dissertation, I reduce aggregation bias by employing trade data at a much more disaggregated level, i.e., at the commodity level. Specifically, I use annual data from 1978 to 2002 of all commodities that were traded between the US and China. In total, the trade data of 88 commodities are utilized. The relationship between the trade balance and the exchange rate does not reveal the whole picture. Thus, in addition to studying the effects of currency devaluation on the trade balance, I also investigate its effects on imported goods and exported goods separately. The methodology (ARDL) is based on the bounds testing approach of Pesaran at al. (2001) to cointegration and error-correction modeling that does not require pre-unit root testing.; For the trade balance, import, and export models, on the basis of F-tests and the error correction terms, I find that there exists a significant long-run relationship between the-dependent variables and their determinants in most cases. Importantly, of the 88 commodities examined, the long-run coefficient obtained for the real exchange rate of the trade balance model is positive and significant in 34 cases, indicating favorable effect of depreciation on the trade balance in the long-run. I find that a real depreciation of US dollar will decrease US imports and increase US trade balance overall in the long-run. The results also suggest that manufactured goods are relatively more sensitive to exchange rate than primary goods in general. The results for the import and export functions indicate that currency depreciation has different effects on imported and exported goods, which should be taken into consideration in setting a country's trade policy. |
