Impacts of Real exchange Rate Volatility and Real Exchange Rate Misalignment on China

Previous analytical models focused on the effects of the real exchange rate (RER) and the RER volatility on Chinese aggregate exports. An important and related variable, the RER misalignment, has been hitherto omitted from the analysis. Yet this has been an issue of paramount importance facing not only China but also the rest of the world. This paper makes the first attempt, using both the theoretical and the empirical models, to examine the impacts of the RER misalignment on China. The theoretical model reveals that some industries exporting to particular countries may lose, while others may gain, from a reduction in the RER misalignment. Using the SUR methodology coupled with the disaggregate panel data, we able to demonstrate the different cross-industry and cross-country effects on Chinese manufacturing exports. The empirical results confirm our theoretical propositions. Our analysis shows that China may not lose from a decision to revalue its RMB against the US dollar because the negative impacts of the revaluation, and its accompanying effects on the RER volatility, if any, on the exports, may be diluted by the positive impacts attributing to a reduction in the RER misalignment or distortion on the Chinese exports