Will RMB appreciation reduce trade deficit in the US?

Abstract

Although the Renminbi (RMB) appreciated by more than 25% against the US dollar in nominal terms between 2005 and 2011, China's exports continued to grow, leading to a surplus, representing approximately for 10% of its GDP. This paper assesses the major explanations for the surge of China's exports and trade surplus and tackles the issue of whether an appreciation of the RMB would help the US to reduce its trade deficits. After conducting simulation exercises on the multi-country macro-econometric Fair model, this paper offers some new explanations for the unexpected surge in China's trade surplus, namely a low overall price elasticity and a high domestic income elasticity for the tradable goods in both countries, and a consequential sluggish price pass-through process of the RMB appreciation on the US market. It thus questions the effectiveness of RMB appreciation as an instrument to restore the trade balance between China and the US.

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