The Euro and the Yuan: Some Political Economy Considerations

Abstract

This paper sets out a political economy model of exchange rates, focusing on the importance of lobbying. Applying it to the Euro and the Chinese Yuan, we show that pressure groups in China can influence the determination of exchange rate. Furthermore, international negotiations could theoretically lead to an appreciation of the Chinese Yuan. We further extend the political economy model to include some of the special characteristics of Chinese trade such as the prevalence of processing trade and foreign-invested enterprises. Our paper makes a theoretical contribution in linking the Yuan, the Euro, trade disputes and politics. High unemployment and sluggish growth in Europe have led many European voters to put pressure on their governments and Brussels to take a tougher stance in trade disputes with China, leading to a form of “China bashing”.