The impact of China’s yuan appreciation

Abstract

The People’s Bank of China announced on June 19, 2010 that it will allow greater flexibility in the RMB-USD exchange rate and by July 30, 2010, the Yuan appreciated by 0.75%. This paper uses the multicountry macroeconometric model developed by Ray C. Fair to estimate the macroeconomic effects of a similar Yuan appreciation over the next few years. It is found that the appreciation can cause a contraction of the Chinese economy while having no significant positive effect on U.S. output, employment and current account balance. Positive effects on U.S. output from a decrease in imports from China are offset by negative effects on U.S. output from increased inflation and from a decrease in U.S. exports to China because of a Chinese contraction. Thus, the paper concludes that it is not advisable for China to allow any significant appreciation of the Yuan. The paper also studies the effect of Rupee appreciation and finds that some of India’s economic variables, such as the current account balance and import price levels, are more sensitive to currency appreciation than those of China.