The external and domestic side of macroeconomic adjustment in China

Christian Thimann and Roland Straub

No 1040, Working Paper Series from European Central Bank

Abstract: This paper sheds new light on the external and domestic dimension of China’s exchange rate policy. It presents an open economy model to analyse both dimensions of macroeconomic adjustment in China under both flexible and fixed exchange rate regimes. The model-based results indicate that persistent current account surpluses in China cannot be rationalized, under general circumstances, by the occurrence of permanent technology or labour supply shocks. As a result, the understanding of the macroeconomic adjustment process in China requires to mimic the effects of potential inefficiencies, which induce the subdued response of domestic absorption to permanent income shocks causing thereby the observed positive unconditional correlation of trade balance and output. The paper argues that these inefficiencies can be potentially seen as a by-product of the fixed exchange rate regime, and can be approximated by a stochastic tax on domestic consumption or time varying transaction cost technology related to money holdings. Our results indicate that a fixed exchange regime with financial market distortions, as defined above, might induce negative effects on GDP growth in the medium-term compared to a more flexible exchange rate regime. JEL Classification: E32, E62

Keywords: China; current account; DSGE modelling (search for similar items in EconPapers)
Date: 2009-03
New Economics Papers: this item is included in nep-cna, nep-dev, nep-dge, nep-mac, nep-opm and nep-tra
Note: 76331
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Journal Article: The external and domestic side of macroeconomic adjustment in China (2010)
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