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International Financial Issues in the Pacific RimGlobal Imbalances, Financial Liberalization, and Exchange Rate Policy$
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Takatoshi Ito and Andrew K. Rose

Print publication date: 2008

Print ISBN-13: 9780226386829

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226387086.001.0001

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Are Currency Appreciations Contractionary in China?

Are Currency Appreciations Contractionary in China?

(p.71) 3 Are Currency Appreciations Contractionary in China?
International Financial Issues in the Pacific Rim
Jianhuai Shi
University of Chicago Press

This chapter examines the relationship between the renminbi (RMB) real exchange rate and China's output by using the vector autoregression (VAR) model technique. The results show that RMB real appreciation has led to a decline in China's output, suggesting that currency appreciations have been contractionary in China, as traditional open economy macroeconomics forecasts. When the international finance linkage of the Chinese economy is accounted for, the effect of RMB real exchange rate shocks on China's output and the power of the shocks in explaining the change of China's output are relatively small, while the effect of U.S. interest rate shocks on China's output is relatively large. The intuition behind this finding may be that the effectiveness of China's capital controls has eroded over time and the scales of capital inflows and outflows have become large enough that external shocks through international finance channels have significant influence on the Chinese economy, exceeding the influence of external shocks through international trade channels. Shocks to domestic money supply and foreign demand also have important effects on China's output. However, government spending shocks have less power in explaining the change of China's output.

Keywords:   renminbi, real exchange rate, vector autoregression model, output, China, exchange rate shocks, capital controls, U.S. interest rates

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