Abstract
The US labeled China a Currency Manipulator in August 2019 because of the massive trade balance surplus of China. The correlation between RMB’s exchange rate and China’s trade balance has been discussed worldwide. The Traditional Marshal-Lerner Condition states if the sum of the absolute value of export and import price elasticity of demand is more than 1, the trade balance will be adjusted through the fluctuation of the exchange rate. However, Traditional Marshal-Lerner Condition requires trade balance is 0 at the beginning, while China benefits the huge surplus of the trade balance for decades. Therefore, the Traditional Marshal-Lerner Condition may not be appropriate to explain why RMB’s exchange rate failed to shrink the surplus of China’s trade balance. The author reconsiders the derivation of Marshall-Lerner condition and presents another Marshall-Lerner condition which illustrates the conditions the export and import price elasticity of demand need to meet when the trade balance is uneven at the beginning so that the fluctuation of exchange rate can play a role in regulating trade balance. Then the industry-level data from January 2008 to June 2018 were used to calculate the export and import price elasticities of demand by using ARDL model. The empirical results show the validity of Traditional Marshal-Lerner Condition in China was investigated, while the Generalized Marshal-Lerner Condition cannot be satisfied during the sample period. Taking the huge amount of surplus, and the movements of RMB’s exchange rate recent years into consideration, the results of Generalized Marshal-Lerner Condition, that the variation of RMB’s exchange rate will not succeed in adjusting the trade balance in the Chinese economy, maybe more persuasive than the traditional one. Key words: China, Marshall-Lerner condition, trade balance, ARDL model.
Highlights
Since China joined the WTO in 2001, China‟s economic international standing has been rising rapidly due to the development of international trade
The results reveal the long-run relationship between the concerned variables, while the results of the Auto Regression Distributed Lag (ARDL) and ECM model rejected the validity of the ML condition and J-curve phenomenon
Pesaran and Shin (1999) provide the ARDL model, which can be applied to a small sample size such as the one used in this study
Summary
Since China joined the WTO in 2001, China‟s economic international standing has been rising rapidly due to the development of international trade. They use the co-integration model to analyze the relationship between RMB and China‟s export and import Their empirical results reveal that the revised Marshall-Lerner Condition exists, the devaluation of RMB‟s real exchange rate against USD can improve the trade balance, and the devaluation of USD may have negative effects. This paper concludes that why the devaluation of RMB fails to increase trade balance is that the continuous devaluation of RMB leads to the decline of the expected price of China‟s export products and brings about the deflation effect and the postponement of US importers to import China‟s products All of these studies ignored the assumption that China‟s trade balance is not initially even, and they use the country-level data to calculate the export and import price elasticity of demand
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