Download Determine RMB Real Equilibrium Exchange Rate

UNIVERSITY OF MACAU
FACULTY OF BUSINESS ADMINISTRATION
An Empirical Exploration of the Real Exchange Rate
of the RMB: A Wage Perspective
LIU RUOCHUAN
MA957171
Thesis presented to the
Faculty of Business Administration
University of Macau
In partial fulfillment for granting the MBA Degree
2012
Content
Abstract ....................................................................................................................... 1
1. Introduction ............................................................................................................. 2
1.1 Exchange Rate Selection ............................................................................... 2
1.2. China’s situation .......................................................................................... 4
1.3 Wage Factor .................................................................................................. 6
1.4 Hypothesis ..................................................................................................... 8
2. Literature Review .................................................................................................... 9
3. Methodology ......................................................................................................... 13
3.1 Empirical Approach .................................................................................... 13
3.2 Econometric Methods ................................................................................. 16
4. Results Interpretation ............................................................................................ 18
4.1 Stationary Analysis ..................................................................................... 19
4.2 Johansen cointegration analysis .................................................................. 21
4.3 Cointegration Result ................................................................................... 24
4.4 Short Run Relation ...................................................................................... 29
5. Summary and Concluding ..................................................................................... 35
6. References ............................................................................................................. 37
Abstract
Exchange rate is at the heart of international finance, and also remains a central issue in
many disputes of international trade. Mainstream theories study exchange rate based on
the purchasing power parity and a common sense which assume wage level equals labor
productivity. Unfortunately, this assumption may not be true in reality, and existing
theories likely fail to account for trade imbalance especially between developed and
developing countries. This paper does not take that assumption for granted, but will
instead consider a more realistic situation: labor may get underpaid (relative to its
productivity) in some countries or overpaid in others when these countries trade.
Distorted wage level may have certain interactions with the exchange rates of various
currencies. The wage factor is used in this paper to estimate the equilibrium real
exchange rate of the RMB. We expect to see that the comparative advantage of China
trade lies actually in its extremely low wage, not in the alleged currency misalignment,
and RMB may not be undervalued after taking into account distorted factor prices.
Moreover, if the RMB appreciation is forced to continue in a substantial manner, the
degree of wage distortion will be increasing further with adverse impacts on both China
and its trading partners.
1