NBER WORKING PAPER SERIES THE IMPACTS OF RENMINBI APPRECIATION ON TRADES FLOWS AND RESERVE ACCUMULATION IN A MONETARY TRADE MODEL

Transcription

1 NBER WORKING PAPER SERIES THE IMPACTS OF RENMINBI APPRECIATION ON TRADES FLOWS AND RESERVE ACCUMULATION IN A MONETARY TRADE MODEL L Wang John Whalley Workng Paper NATIONAL BUREAU OF ECONOMIC RESEARCH 050 Massachusetts Avenue Cambrdge, MA 038 November 007 The vews expressed heren are those of the author(s) and do not necessarly reflect the vews of the Natonal Bureau of Economc Research. 007 by L Wang and John Whalley. All rghts reserved. Short sectons of text, not to exceed two paragraphs, may be quoted wthout explct permsson provded that full credt, ncludng notce, s gven to the source.

2 The Impacts of Renmnb Apprecaton on Trades Flows and Reserve Accumulaton n a Monetary Trade Model L Wang and John Whalley NBER Workng Paper No November 007 JEL No. E5,F3,F43 ABSTRACT Gven the rapdly growng reserves n Asa (Chna, Japan, Korea, Tawan) and the pressures from tradng partners to revalue, there s a need to examne commercal polcy n more than a pure barter model. Here we evaluate the jont mpacts of exchange rate apprecaton on trade flows and country surpluses usng a general equlbrum trade model wth a smple monetary structure n whch the trade surplus s endogenously determned n the exchange rate settng country and the exchange rate s exogenous. We llustrate ts applcaton to the Chnese case usng calbraton to 005 data. Our results, whle elastcty dependent, suggest that the mpacts of Renmnb (RMB) revaluaton on the surplus are proportonally larger than on trade flows, and that changes n trade flows can be substantal. Dfferent treatments of Chna's processng trade have small mpact on changes n Chna's trade flow under RMB apprecaton, but sgnfcant mpacts on the change n the surplus. Results are elastcty dependent; larger substtuton elastctes n preferences yeld larger effects on trade flows and the surplus. L Wang Department of Economcs Unversty of Western Ontaro London, ON Canada N6A 5C lwang363@uwo.ca John Whalley Department of Economcs Socal Scence Centre Unversty of Western Ontaro London, Ontaro N6A 5C CANADA and NBER jwhalley@uwo.ca

3 . Introducton Gven the rapdly growng reserves and trade surpluses both n major Asan exporters (Chna, Japan, Korea) and elsewhere (Inda, Russa) t s clearly unsatsfactory both to analyze commercal polcy n these countres n pure barter trade models, and to separately analyze the mpacts on trade and reserve accumulaton of exchange rate changes. Despte ths, currently avalable lterature focuses on ether trade polcy changes gnorng monetary structure, or trade mpacts of exchange rate changes n structures where trade pattern changes do not follow from a trade model. Here, we attempt to brdge ths gap usng a trade model wth smple monetary structure n whch the surplus s endogenous. We abstract from all asset holdng and ntertemporal effects and money s smply a medum of exchange reflectng a transactons demand. Money s non neutral snce domestc monetary polcy does not accommodate to the fxed exchange rate, and there s excess supply of foregn exchange to the central bank. The central bank accommodates ths by makng domestc currency nconvertble and absorbng all excess foregn exchange offered. Nowhere are these ssues more pronounced than n Chnese case, where reserves now exceed $ trllon and annual surpluses approach $0 bllon. Ths has generated ntense pressure on Chna to revalue, and as a result there has been substantal nterest n the potental mpacts of a sgnfcant Renmnb revaluaton on trade flows and patterns, as well as n the sze of revaluaton whch mght ultmately be needed to restore external sector balance. Most of the avalable lterature uses econometrc models wth no explct trade structure. Park (005), for nstance, usng the Oxford Economc Forecastng model, fnds that f Chna revalued by 0% the Chnese trade surplus would fall by $5 bllon. Kamada and Takagawa (005), employng the Asan Economy Model, report that a 0% apprecaton of the RMB would cause the aggregate Chnese trade surplus to fall by 0.5% of Chnese GDP. However, as the IMF (005) notes few of these

4 studes report changes n Chna s exports and mports. Marquez and Schndler (006), usng an autoregressve dstrbuted lag model, fnd that a 0% apprecaton of the RMB would reduce Chna s share of world exports by 0.5% and Chna s share of world mports by 0.%. Other studes of Renmnb revaluaton use general equlbrum models n whch monetary structure s absent. The IMF (005), utlzng a partal equlbrum framework, conclude that a 0% Renmnb apprecaton would reduce Chna s trade surplus by $0 bllon. Wllenbockel (006), usng a general equlbrum model wth dfferent fxed labor supply and unlmted labor supply assumptons smulates a revaluaton of the RMB by 4%, and fnds that a 4% RMB revaluaton, would ncrease Chna s exports by 0.5% or 3.6%, and exports would fall by 0.7% or % dependng upon the assumptons used. Another commonly held vew n Chna s that gven Chna s large processng trade and the mportance of FDI nflows for trade performance, trade mpacts wll be small as most export costs are already effectvely foregn currency denomnated. FIEs, for nstance, whch use FDI for platform export producton currently account for around 60% of both Chna s exports and mports, but have wage costs of around $ 30 bllon compared to sales of perhaps $400 bllon. Trade mpacts of RMB revaluaton are also acknowledged to be elastcty dependent, but there are no relable estmates of relevant elastcty parameters for Chna and estmates for other countres are typcally used. In our model, we characterze reserve accumulaton as drven by government or central bank polcy whch sets non accommodatve monetary polcy gven the exchange rate and smply absorbs any supply of foregn currency t s offered (dollars) at the set exchange rate mantanng nconvertblty of domestc currency. We thus develop a smple monetzed extenson of a conventonal trade model wth the added structure that the trade surplus (and surplus nduced addtons to reserves) s 3

5 endogenously determned. To our knowledge ths structure, whle smple, s novel. We use a calbrated form of ths model usng 005 data forward scaled from both the Chnese 000 nput-output table and nternatonal source for earler years when surpluses were smaller. We thus calbrate to the actual 005 surplus. We use a country format, and usng ths calbrated model we are able to compute counterfactuals and assess the potental mpacts of both small to relatvely mld revaluatons of the Renmnb (5%-0%) as well as a larger revaluaton (0%). Our results show larger percentage mpacts on the trade surplus than on trade flows drectly. Trade flow mpacts, n turn, depend crtcally on the elastcty parameters used n the model. Ths data s dscussed n secton 5. 4

6 . Chna s trade flows, foregn exchange reserves and foregn exchange rate regme As the more complex model whch follows s desgned to be reflectve of the stuaton n Chna, we frst dscuss relevant background nformaton on Chna s polcy regme. Both reserve accumulaton n Chna and the large trade surplus are a reflecton of the jont exchange rate and monetary polces pursued by Chna s monetary authortes. The RMB was nconvertble and ts exchange rate was pegged to the dollar through the 960 s to the early 990 s. Wth sgnfcant domestc nflaton, excess demand for foregn exchange resulted wth (n the 980 s and early 990 s) assocated black market actvty. The RMB was devalued to approxmately ts current level n the early 990 s, and nflaton has slowed snce. And wth sharp growth n exports and nflows of FDI, excess demand for foregn exchange has been replaced by excess supply. Ths has been absorbed by the central bank through reserve accumulaton, wth the RMB nconvertble. The ndcatons are thus of a sgnfcant and growng RMB msalgnment especally from 00 on, wth the Chnese government mantanng rgd exchange rate regulatons and a peg of the RMB aganst the US Dollar at a fxed rate. In July 005, when around 70% of the reserves were n US bank notes, under the pressure from the US government, the Chnese government announced an effectve.4% revaluaton of the RMB aganst the dollar and commtted to future exchange rate targets n terms of a trade-weghted currency basket. Gven the potental nflatonary consequences of large accumulaton of foregn reserves, the Chnese government partally sterlzes ts foregn reserve acqustons by ssung central bank blls and bonds as well as through controls on bank lendng. Despte these sterlzaton efforts, M grew by 9% n 003 and 6.9% n 005, but gven strong Chnese growth, nflaton as measured by the CPI rose from.% n 003 to.8% n 005 (NBS, 003, 005). 5

7 On the trade sde, between 000 and 004, the average growth n Chna s mports and exports exceeded 0% and kept growng n 005 and 006. The resultng trade surplus sharply ncreased Chna s foregn exchange reserves (See Fgure ). In 005, the trade surplus also ncreased due to a slowng down n the growth rate of mports, followng restrctons that the Chnese government ntroduced n 004 to cool the boom, and a growth n exports of apparel, followng the abolton of the mult-fber agreement (MFA) n January 005. However, wth contnung export growth n many sectors, not just n apparel, by 006, Chna s foregn exchange reserves had reached $ trllon n comparson wth only $65 bllon n bn$ Fgure Chna's export, mport and reserves durng export mport reserves year Data source: Chna s exports and mports from NBS, Chna Statstcal Year Book between 997 and 004; and from NBS, Statstcal communqué of the People s Republc of Chna on the 005 (006) Natonal Economc and Socal Development for 005 and 006. Foregn currency reserves are from State Admnstraton of Foregn Exchange, PRC. The growth rates for Chna s exports and mports n 005 and 006 are: 8.4% and 7.% for exports, 7.6% and 0.0% for mports. 6

8 Whle Chna s rapd accumulaton of US dollar reserves has been prmarly drven by a growng trade surplus over 0 years, other factors have also contrbuted. One has been net nward FDI flows whch, whle growng at a relatvely moderate pace, average around $60 bllon per year. Speculatve portfolo and other nvestment nflows n antcpaton of a RMB apprecaton are also beleved to have played an mportant role n Chna s reserve accumulaton. In the last year or so, reserves have ncreased by more than $00 bllon. The pressure on Chnese authortes to revalue the RMB has correspondngly grown, and wth t have come concerns over the mpact of any sgnfcant further revaluaton on performance, and especally trade performance. Arguments that lttle mpact wll result focus on a sgnfcant processng component of trade n whch both nputs (mports) and outputs (exports) are foregn currency denomnated, and elastctes whch have to be unrealstcally hgh for sgnfcant mpacts to occur. The alternatve vew that mpacts wll be larger focuses on a range of factors whch wll fuel larger mpacts ncludng FDI nflows and changes n speculatve captal flows. 7

9 3. A smple monetary trade model of the Chnese exchange rate and trade regme To analyze the mpacts of RMB apprecaton we use a smple trade model wth monetary structure. In ths mpacts on speculatve captal flows and FDI nflows are put on one sde, and t s the endogenety of the trade mbalance va reserve accumulaton to support a fxed exchange rate. Ths addtonal monetary structure s mssng n other related modelng work such as Wllenbokel (006). We depart from classcal monetzed extensons of real sde barter type trade models where money s neutral. In such models, n a two country world each wth a natonal money and a smple fxed velocty transactons money demand, once the domestc money stocks are specfed exchange rates are endogenously determned. There are no effects of ntroducng money on consumpton, producton or trade. Any change n ether or both country money stocks results n a change n the exchange rate between the natonal mones, but wth no mpact on real trade flows. Alternatvely, f a fxed exchange rate s specfed then monetary polcy n the two countres has to be accommodatve n the sense that the rato of the two natonal money stocks must be consstent wth the fxed exchange rate. In these smple models money s only a medum of exchange and no fnancal assets enter. There s also no tme structure and a sngle perod world s assumed. A smple transactons money demand and fxed money stock determnes prces of goods n terms of money. In the money neutral case, a strct separaton between real and monetary phenomena apples n that relatve goods prces are determned by the real sde of the nternatonal economy and the country prce levels (and hence money prces) are determned by the money stock. Our approach s to specfy a monetary regme n a model wth monetary non-neutraltes reflectng the actual Chnese exchange rate and monetary regme. In 8

10 ths, model wth monetary non-neutraltes monetary polcy s non accommodatve to the chosen fxed exchange rate, and ths mples ether excess demand for or excess supply of foregn exchange. Chna was an economy n whch up to the md-990s there was sgnfcant excess demand for foregn exchange wth assocated ratonng and black markets, but from the md-990s on the excess demand regme became one of excess supply. By mantanng the nconvertblty of the Renmnb foregners are prevented from sales of foregn exchange at better rates, and the exchange rate s mantaned by the central bank buyng foregn currency to absorb ths excess supply through addtons to reserves. Ths, n turn, supports the Chnese surplus on trade account. Ths s equvalent to nterventon based stock plng to support a prce control (n ths case the fxed exchange rate, see Iman and Whalley (98)). Later, we use a calbrated numercal model of Chna wth a producton sde and monetary structure to analyze the mpacts of changes of exchange rates n ths regme, but we frst expost a smple verson of ths structure. We consder a smple good (good and good ) country (country and country ) pure exchange world, where and are the ntal endowments of goods and n countres and.,, and ( j ) denote the demands for good ( =, ) n country j ( j=, ). Each country s assumed to have a representatve consumer wth a utlty functon: j j U ( ) =,, j=, () Unlke n a conventonal trade model, we ncorporate the endogenously determned trade surplus drectly nto the two country budget constrants. We also assume that the surplus country s predetermned as country ( Chna) and the defct country as country (the rest of the world) and Country fxes ts exchange rate and has non-accomodatve monetary polcy. Country wll be assumed to fx ts money stock. Ths mples that jontly countres and exhbt relatve money stocks nconsstent 9

11 wth the fxed exchange rate and monetary non neutraltes result. We assume ths to be a reflecton of polcy choces by country. Denotng e as the fxed exchange rate chosen by country (Chna), and S as the endogenously determned surplus denomnated n the currency of country (the rest of the world), the budget constrant for country s p + e p = p es () and, for country : p e + p = p + S (3) Unlke n real sde models that accommodate trade mbalance as exogenous transfers, here S s endogenously determned, gven e and relatve domestc money stocks. For country, frst order condtons for utlty maxmzng behavor yeld U ( U ) /( p ) = e p and smlarly, for country, U ( U ) /( ep ) = p (4) (5) If, for smplcty, we assume a velocty of crculaton of unty n both countres, and a money stock n country of m and n country of m, money demand and supply equatons are: and p m p + = (6) p + S m p + = (7) Addng demand supply equaltes n goods gves equaton (8) and (9) + = (8) 0

12 + = (9) Equaton (3)-(9) thus gve a system of 7 equatons n 7 unknowns (,,,, p, p, S ) for whch e and m are polcy parameters for country gven the settng of m n country. Thus, f county s Chna and t changes the exchange rate for a gven m there wll be real sde effects. In ths model, the exchange rate settng acts as prce nterventon now supported by stock plng of foregn exchange. Changes n e n turn drectly mpact on S, as well as on real sde quanttes and trade. We can llustrate how ths smple system operates wth a smple numercal example. We assume the utlty functons n () to be Cobb Douglas and use the parameter settngs generated by calbraton to an artfcal data set n Table. We then compute an equlbrum for ths structure and nvestgate the mpacts of changes n e on S and other real sde varables. Smulaton results outlned n Table shows that wth apprecaton of the currency n country (exchange rate reductons of 5%, 0% and 0%), country s mports ncrease, whle ts exports decrease. The trade surplus decreases, and as we suggest earler, the proportonal effects of changes n the exchange rate on the surplus ( S ) are consderably larger than the effects on trade flows (.e. on and ).

13 Table An example of exchange rate revaluaton n a smple monetary trade model A. Artfcal benchmark data used to calbrate a smple good pure exchange economy Value of consumpton n base case n domestc currency prce Domestc currency prces n base case good good good good Endowments Money stock n Country ( ) 0 ( m ) Country ( ) 30 ( m ) Base case exchange rate: : Base case surplus: 0 unts of country currency accumulated by country B. Calbrated model parameter Cobb-Douglas preference parameters generated by calbraton good good country country C. Results of changes n the exchange rate and monetary polcy decrease n e by % change n S % change n % change n 5% % % ncrease n m by 5% % %

14 If, nstead of changng e, we nstead ncrease the money stock n country by the same percent as the change n exchange rate, ncreasng m causes goods prces n country to fall and ths ncreases country exports, and the trade surplus falls. In ths smulaton, equal percentage changes n e and m produce smlar, but not dentcal, mpacts on trade and the surplus. 3

15 4. A smple trade-monetary model structure for Chna wth producton and processng trade We next assess the mpacts of RMB revaluaton n a more complex model wth sectoral detal, producton structures, and also consder the role of processng trade. We calbrate the model to 005 data and agan perform counterfactuals. We set out our procedures for constructng a model benchmark data set later. In ths, we use data for earler years whch we frst scale to 005 for changes n ntervenng years. 005 s used as the base year snce the surplus was consderably larger than n earler years. A key element of ths more complex model of Chna s ts treatment of processng trade. Processng trade uses mports as nputs and apples value-added n upgradng for exports. Imports for ths purpose are dfferentated from those enterng fnal demands. We thus treat a part of mports as for fnal consumpton, and a part for use as ntermedate nputs, whch are effectvely for re-export from Chna. In 005, processng trade accounted for 4 percent of Chna s mports from the world, and 55 percent of Chna s exports to the world (NBS. 005). Other mports are domnated by ol and raw materals. The model ncorporates a fxed exchange rate regme smlar to that n the smple model dscussed above. We consder 3 sectors: agrculture and energy, manufactures and other sectors (ncludng servces) whch account for.4%, 47.3% and 40.3% of GDP n 005, and of 44.8%, 3.8% and 3.4% of employment. We ncorporate processng trade nto the producton structure only n the Chna part of the model; the rest of the world s scaled to reflect ts relatve sze compared to Chna, but s modeled n full form as a dstnct economy. On the producton sde n Chna, we consder a 3 sector system, n whch processng trade s specally treated. The producton functon n each sector n country ( ) s Y = g( L, K, N ) =,, 3 (0) where refers to dfferent goods, and Y, L, K, N are the outputs of 4

16 country, labor and captal nputs, and the processng trade nput. pl, pk, pn are the prces of labor, captal and processng trade nputs n country. Frst order condtons yelds: pl g = p () L pk = p g K pn = p g N Country s producton nvolves only labor and captal nputs, wth no processng trade nput, as follows: Y = g( L, K Frst order condtons are: ) pl g = p () L pk = p g K Fnal demands for commodtes n country and country as modeled as derved from CES nested utlty functons defned over compostes of smlar domestcally produced and mported goods. Ths structure allows us to drectly ncorporate substtuton elastcty parameters nto the model as the substtuton elastcty between smlar domestc and mported goods whch can then be drectly related to mport demand elastctes, Ths yelds a relatvely conventonal Armngton type trade model but wth dfferent producton structures n the two countres. Maxmzng country s utlty yelds demands from the soluton to a stage budgetng problem, e: max { C ( D, D )} U (3) 5

17 st. p D + ep D = p Y es where C s the CES composte of good n country, D ( D ) s the demand n country for good produced n country (), and S s the surplus. Country s demand are smlarly derved by maxmzng a nested CES utlty functon defned over CES compostes of mported goods from country and domestcally produced goods. max { C ( D, D )} U (4) st. p D + p D = e p Y + S As before, we assume each country s money supply s fxed, and each country has a constant velocty transactons demand. In equlbrum, ths mples: and pd + pd = m (5) p D pd + S = m + Addng demand supply equaltes n goods gves D + D = Y (6) D + D + N = Y Fnally, factor market clearng condtons are: L = L (7) L K K = L = K = K 6

18 An equlbrum can be computed for ths system smlarly to that for the example above. We buld a model admssble data set for 005 for ths structure and perform counterfactual experments for changes n e and /or m. We also ncorporate a tarff on mports nto the model, and are able to analyze the effects of trade polcy changes n the presence of the monetary non-neutraltes specfed. 7

19 5. Data and parameterzaton Our model ncorporates countres and 3 traded goods (agrculture and energy, manufactures, and other sectors) and we buld a model compatble benchmark equlbrum data set for calbraton (see Dawkns, Srnvasan and Whalley 00). We use a base year of 005 snce the surplus n Chna was larger n that year than earler and we scale earler years data to ths base. The two countres n our smulatons are Chna and the rest of the world. Due to the mult-country character of the data set, ensurng model consstency of data s a problem n buldng the benchmark data. We jontly use data from GTAP on trade, producton, and consumpton as well as Chna s latest nput-output table. We frst use sectoral gross output, total mport and export for Chna and the rest of the world from GTAP 5 database for 997. We use data from Chna s 000 nput-output table yeldng Chna s gross output, and totals for mports and exports. Usng share data from GTAP and Chna s data from the nput-output table, we generate Chna s sectoral gross output, mport and export data for 000. Chna s exports are taken as mports by the rest of the world from Chna. All data s scaled to 005 as follows. Sectoral exports scaled to 005 accordng to the Chna s exports data from NBS and sectoral share n 000. Then exports are kept unchanged. In adjustng benchmark data to reflect the 005 surplus, mports are nstead scaled for consstency wth the 005 surplus, ths mples aggregate surplus for Chna s compatble wth the surplus actually observed n the year. Gross output for the rest of the world and Chna are also scaled to 005 that reflect GDP growth rate from the 000. We ncorporate processng trade data nto the basecase data set as follows. We splt total mports of Chna nto fnal and ntermedate demand components. The shares of mports for fnal and ntermedate use are calculated usng data from the NBS of Chna 3. Intermedate mports are an element of domestc demand. Table reports the 3 Chna s customs comples statstcal data on mports for fnal and ntermedate use by good each year. Due to lack of such data for 005, we use the aggregate share of ntermedate mports of the total accordng to the NBS. 8

20 base case data for Chna and the rest of the world use n our calbraton. For smplcty, we use Cobb-Douglas producton functons to represent the technology of the countres wth shares calbrated to the 005 benchmark data. In the case of Chna, share parameters extend to the use of processng trade nputs. On the demand sde, we use CES compostes and ntally set substtuton elastctes to equal to n both countres. We use ths as the central case although the lterature provdes dfferent estmates of ths key elastcty. Many of the estmates of domestc and mport good substtuton are around or greater than (See Betna (003)). Table 3 reports parameter values n producton and preferences generated by calbraton, as well as shares of ntermedate mports n Chna s mports that are used n counterfactual analyss. 9

21 Table Country Base Case Data n 005 for Chna and ROW (the Rest of the World) used to calbrate the model Chna (n bllon RMB* 4 ) Value of Producton Value of Consumpton Exports to ROW Import from ROW Net trade Agrculture and energy Manufacturng Other sectors Surplus 0.9 Exchange rate : m ROW (n mllon US$) Value of Producton Value of Consumpton Exports to Chna Import from Chna Net trade Agrculture and energy Manufacturng Other sectors Surplus -0.9 Exchange rate : m The currency unt used here for Chnese domestc currency s artfcal n that we set t to 8.77RMB whch s the exchange rate of the US dollar to Renmnb n 00, ths mples that unt RMB* equals US dollar before we scale all the data for 005. Ths conventon s adapted so that n calbraton all equlbrum prces wll be unty. 0

22 Table 3 Parameters for the model generated by calbraton and used n numercal smulaton A. Shares n Cobb-Douglas producton functons 5 Chna Rest of the World Share on captal Shares on labor Shares on ntermedate Share on captal Shares on labor Shares on ntermedate Agrculture and energy Manufacturng Other sectors B. Share parameters for mport and domestc goods n nested CES utlty Chna Rest of the World Domestcally Domestcally Imports produced goods Imports produced goods Agrculture and energy Manufacturng Other sectors Shares of ntermedate mports of Chna Arc estmates of mport demand elastctes used for 005 for Chna Agrculture and energy Manufacturng Other sectors The orgnal data are from the GTAP 5 database. We aggregate sklled and un-sklled labor and generate a labor endowment for Chna and the rest of the world. Land and sector specfc resources are not taken nto account n the producton data used. 6 Statstcal communqué of the People s Republc of Chna on the 00 Natonal Economc and Socal Development (n Chnese) from Natonal Statstcal Bureau, PRC reported only a general processng trade volume whch s about $76 bllon, and share about 4% of the total mport. As the processng trade n Chna s occurred mostly n manufacturng trade rather than n agrculture and servces sectors, we shft all processng trade nputs nto the manufacturng sector, and thus the share here s 56.6%.

23 6. Model results for jont trade and surplus mpacts of Renmnb revaluaton and changes n monetary polcy We have used our calbrated model to smulate the mpacts of RMB revaluaton jontly on Chna s trade flows and the trade surplus. We frstly consder apprecatons of the RMB by 5%, 0% and 0% respectvely wth a fxed money stock n both Chna and the rest of the world. Then we fx the RMB exchange rate and ncrease the money stock n Chna to assess the effects of changes n money stocks on trade flows and the surplus. We are also able to analyze trade polcy changes n a monetary model. Results are presented n Tables 4 and 5. Table 4 shows that wth apprecatons of the RMB of 5%, 0% and 0% respectvely, Chna s mports ncrease n quantty terms by around.8%, 5.7% and 6.5% for these cases, and exports fall n correspondng cases by 9.7%, 8.9% and 35.8%. Chna s trade surplus falls n larger percentage terms by.7%, 5.8% and 53.7% for these cases, mostly due to changes n the quantty of net trades. Wth Renmnb revaluatons of 5%,0% and 0%, the surplus decreases by $.9 bllon, $6.3 bllon and $54.6 bllon respectvely; small changes n prces also nfluence the change n the surplus. Thus, as n the earler numercal example, the proportonal change n the surplus s much larger than the change n trade flows. We then ncrease Chna s money stock m by 5%, 0% and 0%, the same percentage changes as for the exchange rate. Wth the resultng ncrease n the prce level n Chna, Chna s mports ncrease by.8%, 4.4% and 5.4%, and Chna s exports fall by 9.7%, 8.% and 3.8%. The trade surplus falls by 6.7%, 33.% and 65.% n these cases. Agan, the proportonal change n the surplus s consderably larger than the change n trade flows.

24 Table 4 Smulaton results for the mpacts of revaluaton of the Renmnb on trade flows, Chna s trade surplus, and Chna s terms of trade (central case 7 ) Sze of RMB* revaluaton 5% 0% 0% % change n mports In value terms In quantty terms % change n mports of agrculture and energy sector manufacturng sector other sector % change n exports In value terms In quantty terms % change n exports of agrculture and energy sector manufacturng sector other sector Chna s trade surplus % change compared to base case Change n $ bllon In the central case model specfcaton, σ = comparable domestc and foregn goods., whereσ refers to the elastcty of substtuton between 3

25 Table 5 Impacts of varaton n Chna s monetary polces on trade flows, Chna s surplus and terms of trade (central case σ = ) Increase n money stock n Chna 5% 0% 0% % change n mports In value terms In quantty terms % change n mports of agrculture and energy sector manufacturng sector other sector % change n exports In value terms In quantty terms % change n exports of agrculture and energy sector manufacturng sector other sector Chna s trade surplus % change compared to base case Change n $ bllon

26 We next turn to the mpacts of changes n exchange rates that actually occurred n Chna between 005 and 006. Chna s reforms n the exchange rate regme started n July 005. From then to the end of 006, Chna s RMB apprecaton was close to.4% ( the exchange rate for the US dollar to RMB decreased from 8.7 n st July, 005 to n 30th Dec ) and M ncreased by.8% n 005 accordng to the NBS (NBS,005). Ths RMB apprecaton together wth Chna s ncreasng money stock 9 had sgnfcant mpacts on foregn currency reserves. Our smulatons show that wthout Chna s jontly usng a revaluaton of the Renmnb and a monetary loosenng, the surplus would have ncreased by a further.4% (Table 6), whle mports would ncrease of further 7.7% and export fall a further 8.% under the model assumptons. We also use the model to assess the mpacts of tarff rate changes on trade flows and the surplus. We assume dfferent tarff rates on manufactures of 6%, 8%, 0% and % and elmnate them. Results are reported n Table 7. Wth the resultng decrease n mport prces, Chna s mports ncrease by 6.%, 8.0%, 9.8% and.4%. Exports show very small mpacts and n ths model, n contrast to a non monetary trade model, the adjustments nduced by the mport rse are nearly all on the surplus whch ncreases between 4.3% and 7.9%. In contrast to barter economes n whch tarff acts as a tax on exports, here the buffer stock of endogenous reserve accumulaton removes ths effect. It s not surprsng that our smulaton results are elastcty dependant, and the key parameter n the model s the substtuton elastcty between domestc and foregn products n the utlty functon. Table 8 provdes smulaton results under changed substtuton elastctes n CES demand functons only for Chna from 0.5 to. Changes n Chna s mport are senstve to ths elastcty, whle change n exports to the rest of the world shows almost no change. The resultng changes n Chna s 8 Data from The People s Bank of Chna, accessed at 9 We adjusted growth rate of money stock n smulaton usng GDP growth rate. 5

27 surplus vary by a factor of. Table 6 Impacts of Chna s monetary polces n 005 on trade flows, Chna s surplus and terms of trade (central case 0 ) Renmnb Apprecaton Increase n money stock n Chna Jont effects.40%.80% % change n mports In value terms In quantty terms % change n mports of agrculture and energy sector manufacturng sector other sector % change n exports In value terms In quantty terms % change n exports of agrculture and energy sector manufacturng sector other sector Chna s trade surplus % change compared to base case Change n $ bllon See footnote 8. 6

28 Table 7 Impacts of elmnaton of Chna s tarffs on trade flows, Chna s surplus and terms of trade Assumed Chnese tarff rate on manufacture n the base case 6% 8% 0% % % change n mport In value term In quantty % change n mport of agrculture and energy manufacturng sector other sector % change n export In value term In quantty % change n export of agrculture and energy sector manufacturng sector other sector Chna s trade surplus % change compare to base case Change n terms of trade

29 Table 8 Senstvty of RMB revaluaton mpacts to elastcty parameters n demand Varyng the elastcty of substtuton between domestc and foregn products only n Chna Impled mport demand elastcty % change n mports n value terms (Degree of RMB revaluaton) 5% % % % change n exports n value terms (Degree of RMB revaluaton) 5% % % % change n surplus (Degree of RMB revaluaton) 5% % % Because we use a CES form n the code, we use rather than here n executon. 8

30 Table 9 Senstvty of RMB revaluaton mpacts to assumptons made on the sze of Chna s processng trade Varyng the assumed fracton of mports n ntermedate producton n base data (processng trade) (base case) 0.6 % change n mports of Chna n value terms Degree of RMB revaluaton 5% % % % change n exports to ROW n value terms Degree of RMB revaluaton 5% % % % change n surplus Degree of RMB revaluaton 5% % %

31 As we dscussed earler, processng trade n our model s specally treated and changes n model treatment mpact results. We change the share of processng trade by alterng the proporton of mports to domestc demand n the base case data used n calbraton. Result n Table 9 show cases n whch varatons n the mpacts of RMB revaluaton on Chna s surplus are large, but the varatons n mpacts on trade flow change are smaller. These results reflect the dampenng effect of processng trade nputs on revaluaton effects. The larger the processng trade, the more that both nputs and outputs are foregn currency denomnated and the smaller the mpacts on the surplus. 30

32 7. Concluson Here we show how the mpacts of changes n exchange rates and monetary polcy can be analyzed n a trade model wth a smple monetary structure n whch the trade surplus s endogenously determned and exchange rate polcy s exogenous. In ths model, money s non neutral. We llustrate the model s applcaton usng a calbrated Chnese model ncorporatng 005 data. We fnd that mpacts of revaluaton Renmnb on the surplus are proportonally larger than on trade flows. Impacts on trade flows and the surplus are both substantal. A separate treatment of Chna s processng trade s also ncorporated nto the model. Varyng the fracton of mported ntermedate to total mports has lttle effect on the mpacts of trade flow changes under dfferent degree of revaluaton, but has a sgnfcant nfluence on the surplus due to changes n net trade. These mpacts are also elastcty dependent. Our results show that larger substtuton elastctes between domestc and foregn producton n demand n Chna yelds larger effects on trade the flow and the surplus. Snce Chnese polcymakers mplemented current and captal account lberalzaton measures n 005 amed at addressng macroeconomc mbalances, we also analyze these. Our smulatons show that these polces had an mpact n depressng the growth n the surplus, whch would otherwse have been larger. 3

33 References Betna V. Dmaranan, Robert A. McDougall, and Thomas W. Hertel (006), GTAP Verson6 Documentaton: Chapter 0 Behavoral Parameters accessed at Cooper Rchard N (006). Lvng wth global mbalances: A contraran vew, Journal of Polcy Modelng 8 (006) Dawkns, C., T.N. Srnvasan, and J. Whalley (00), Calbraton, n J.J. Heckman and E.E. Leamer, eds., Handbook of Econometrcs: Volume 5, Elsever Scence. Dean, Judth M., K.C. Fung and Zh Wang (007), Measurng the Vertcal Specalzaton n Chnese Trade, U.S Internatonal Trade Commsson, Offce of Economcs, Workng Paper No A. Frankel, Jeffrey (006), On the Yuan: The Choce between Adjustment under a Fxed Exchange Rate and Adjustment under a Flexble Rate CESfo Economc Studes, Vol. 5, /006, Imam, Hasan and John Whalley (98), General Equlbrum wth Prce Interventon Polces: A Computatonal Approach, Journal of Publc Economcs, 8() June 98, pp IMF (005), Asa-Pacfc Economc Outlook, Internatonal Monetary Fund, Washngton, DC. Kamada,, K., and Takagawa, I.( 005), Polcy Coordnaton n East Asa and across the Pacfc, Bank of Japan Workng Paper Seres No. 05-E-4 (Bank of Japan, Tokyo). Marquez, J., and Schndler, J.( 006), Exchange Rate Effects on Chna s Trade: An Interm Report, Federal Reserve Internatonal Fnance Dscusson Paper No. 86 (Federal Reserve Board, Washngton). Natonal Bureau of Statstcs, PRC, Chnese Statstcal Yearbook, accessed at Natonal Bureau of Statstcs, PRC (000, 00, 003, 005, 006), Statstcal communqué of the People s Republc of Chna on the 000 (00,003,005,006) Natonal Economc and Socal Development (n Chnese). accessed at 3

34 Park, C.(005), Copng wth Global Imbalances and Asan Currences, Avalable at: Thorbecke, Wllem (006), How Would an Apprecaton of the Renmnb Affect the U.S. Trade Defct wth Chna? Topcs n Macroeconomcs Volume 6, Issue Artcle 3, accessed at Voona,Jan P, L Guangzhong and Jmmy Ran (006), Does Chna really lose from RMB revaluaton? Evdence from some export ndustres, Appled Economcs, 006, 38, Whalley John (006), The Post MFA Performance of Developng Asa, NBER workng paper 78 Wllenbockel, Drk (006), Structural Effects of a Real Exchange Rate Revaluaton n Chna: A CGE Assessment, MPRA Paper No. 90, Onlne at mpra.ub.un-muenchen.de/ 90/ Zhang, Z. (00), Real exchange rate msalgnment n Chna: an emprcal nvestgaton, Journal of Comparatve Economcs, 9, Zhang Fan, Zuohong Pan (004), Determnaton of Chna s long-run nomnal exchange rate and offcal nterventon, Chna Economc Revew, volume 5, ssue 3. 33