China's Exchange Rate Policy Do The Right Thing?

China’s foreign trade has made extraordinary achievements since its reform and opening up and the growth was even faster after it joined the World Trade Organization. With the rapid growth of the foreign trade, China has also accumulated a huge amount of trade surplus and the trade between China and the rest of the world become imbalanced.The RMB exchange rate and China’s exchange rate policy was accused to be responsible for the huge imbalance and whether China should change its exchange rate policy and allow its currency to appreciate became a hot debate in the world. When talking about the exchange rate policy, the shock the exchange rate may put on the foreign trade especially on the export is always among the hot topics. Besides the rapid growth of the export on the aggregate level, the structure of China’s export has also changed dramatically. Following the traditional classification in many studies, this paper classified the export into labor intensive products and capital and technology intensive products and estimated the export exchange rate elasticity for the two groups of products. The newly appeared ARDL-ECM method for co-integration overcomes the shortcomings of the traditional EG two steps method and Johansen test method. Through this method, the study found that the export exchange rate elasticity for capital and technology intensive products was significantly smaller than that of the labor intensive products. This conclusion was also supported by the estimated results from single equation estimation and estimations based on SITC one digit level data, which means the conclusion is quite robust.Combining the trend of the structure change of China’s export and the different export exchange rate elasticity of the two groups of products, it is quite obvious to say that the shock brought by the change of exchange rate policy to loosen the exchange rate control is limited and the pros brought by the change overcome the cons in the long term. However, there are still some shocks in the short term and the government should be cautious on choosing the timing of exchange rate policy change.