A twelve-area model for the equilibrium Chinese Yuan/US dollar nominal exchange rate

• Published in: Journal of international financial markets, institutions & money institutions & money, 2012-02, Vol.22 (1), p.151-170
• Main Authors: You, Kefei, Sarantis, Nicholas
• Format: Article
• Language: English
• Subjects: Capital market; China; Current accounts; Economic theory; Equilibrium; Estimation; Exchange rates; Foreign exchange rates; Fundamental equilibrium exchange rate; International trade; Investment analysis; Macroeconomics; Nominal CNY/USD; Parameter estimation; Structural breaks; Studies; TABEER model; U.S.A
• ISSN: 1042-4431; 1873-0612
• DOI: 10.1016/j.intfin.2011.08.005

► We examine the equilibrium CNY/USD nominal exchange rate using a twelve-area model. ► We account for structural breaks and highlight macroeconomic determinants. ► The equilibrium nominal rate was overvalued from early 1990s until 2003. ► It is strongly undervalued during 2004–2008. ► A three percent sustainable current account leads to larger undervaluation. This paper investigates the equilibrium CNY/USD nominal exchange rate during 1976–2008. We extend for the first time the five-area FABEER model to a twelve-area TABEER model for China. All parameters are estimated with allowance for endogenous structural breaks. Our investigation of the sustainable current account highlights macroeconomic factors that determine savings and investment in the medium-term. We find that all cointegration relationships are subject to structural breaks. The equilibrium nominal rate was overvalued in most years from early 1990s until 2003. It has been strongly undervalued during 2004–2008. We further compute misalignment rates using a sustainable current account of 3%. Our findings suggest such exogenous input leads to results biased towards larger undervaluation.