Estimating renminbi (RMB) equilibrium exchange rate

It is claimed that China's currency market interventions have caused massive trade imbalances in favor of China. Without an accurate estimate of RMB's long-run equilibrium value, however, the validity of this claim can't be ascertained. This paper aims to place the debate about the degree of RMB's misalignment in a tractable framework by estimating the long run equilibrium real effective exchange rate of the currency. Based on estimation of the behavioral equilibrium exchange rate (BEER) and using Johansen co-integration technique, we conclude that RMB fluctuates around its long-run equilibrium rate within a narrow band. This implies that the currency has not been consistently undervalued. We identify the money supply, the foreign reserve holdings of China's central bank, and a measure of China's productivity as important explanatory variables of renminbi long-run equilibrium value. A discussion of the implications of the empirical findings of this study indicates that China's exchange rate policy may have played an insignificant role in its trade surpluses. (C) 2007 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.