The Overvaluation of Renminbi Undervaluation the Overvaluation of Renminbi Undervaluation

Acknowledgments: An earlier version of the paper was circulated under the title " Why the Renminbi Might Be Overvalued (But Probably Isn't). " We thank the discussant Barry Eichengreen, Michael Klein (whose suggestion inspired the title), Science research grant is gratefully acknowledged. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Abstract We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference. A framework built around the relationship between relative price and relative output levels is used. We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued. The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables. 1 1. Introduction China's currency, the Renminbi (RMB), has occupied a central role in the ongoing debate over the source of global current account imbalances. In this paper, we step back from the debates over the merits of one exchange rate regime versus another and whether a currency realignment is desirable (although our conclusions will necessarily inform the debate over what the appropriate actions might be). Rather, we focus the discussion of currency misalignment in terms of economic theory and empirics; in particular, we focus on the difficulty in measuring the " equilibrium real exchange rate " and on quantifying the uncertainty surrounding the measurement of the level of the equilibrium. In so doing, we sharpen our definition of what constitutes currency misalignment, at the cost of restricting the generality of our conclusions. Specifically, we exploit a well-known relationship between deviations from absolute purchasing power parity and real per capita income using panel regression methods. By placing the RMB in the context of this well-known empirical relationship exhibited by a large number of developing and developed countries, over a long time horizon, this approach addresses the question of where China's real exchange rate stands relative to the " equilibrium " level. In addition to calculating the numerical magnitude of the degree of misalignment, we assess the estimates in the context of statistical uncertainty. In this respect, we extend the standard practice of considering both economic and statistical significance in coefficient estimates to the prediction aspect. We also extend the analysis by allowing for heterogeneity across country groupings and time periods. …