RMB Exchange Rate In The Adjustment Of China's External Imbalance

Since the accession to the WTO on the November 10, 2001, China has experienced continued external economic imbalances. The trade surplus is expanding every year, resulting in the rapidly rising current account surplus and the inflow of foreign exchange reserves, which caused a problem of excess domestic liquidity. Faced with this situation, is the recently soaring real exchange rate able to make China's trade surplus decrease, to effectively adjust China's external economics and guide the restoration of balance? If so, then how much exactly would be the impact on the China's total imports and exports and trade surplus? These are the main problems in the paper.Generally speaking, researchers on this issue implement empirical models to estimate the price elasticity of import and export to drive the conclusion of whether China satisfies Marshall-Lerner condition judging by the sum of the absolute values of the price elasticity. If the sum is larger than 1, the exchange rate policy is effective in decreasing trade surplus. But no one ever gave a convincing answer to the question of the quantified impact of the appreciation on the trade balance. This paper starts from the definition of trade balance and through total differentiation expresses the price elasticity of trade balance as a function of the price elasticity of import and export, the income elasticity, the coefficient of vertical specialization as well as the imports and exports, taking into account the relation between imports and exports. Furthermore, this paper gives more reliable estimates of the real exchange rate elasticity of trade balance with the weighted average adjustment method based on the 62 sub-sectors in accordance with the SITC division. Main conclusions are that the real exchange rate appreciation of RMB would lead to declining exports and weak imports fall, while trade surplus dropped significantly, which helps to improve China's external economic imbalances.Compared to the research by other scholars, the contribution of this paper is as follows:1) The real exchange rate elasticity of trade balance is derived based on a theoretical model, which helps to analyze the transmission mechanism;2) The real exchange rate elasticity of imports, exports and trade balance are directly estimated and calculated, the latter of which is the first of its kind in China's research;3) The adjustments concerning with vertical specialization and aggregate bias are made to minimize the estimation error;4) The data is carefully examined and processed, including the choice of the period and frequency, as well as excluding inflation and seasonal effects.To sum up, this paper sheds new lights on the research of the real exchange rate elasticity of imports, exports and trade balance; and points out a direction of more detailed future study on this issue.