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The External And Domestic Side Of Macroeconomic Adjustment In China

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Executive Summary

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 mimicking 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.

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