Industry‐specific Real Effective Exchange Rate for China: 2000–2009

• Date: 01 September 2013
• Author: Mi Dai,Jianwei Xu
• Published date: 01 September 2013
• DOI: http://doi.org/10.1111/j.1749-124X.2013.12041.x

100 China & World Economy / 100–120, Vol. 21, No. 5, 2013

©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Industry-specific Real Effective Exchange Rate

for China: 2000–2009

Mi Dai, Jianwei Xu*

Abstract

This paper measures the industry-specific real effective exchange rate (REER) for China by

matching domestic and foreign industry-level price and trade data series. We find that after

2005 the REER appreciates more in the “chemical, plastics, rubber and fuels industry” and

the “machinery and equipment industry,” but remains roughly constant or even depreciates

in other industries. The nominal exchange rate generally accounts for over 50 percent of the

aggregate real effective exchange rate fluctuations, but this conclusion does not apply to

three of nine industries. We apply the industry-specific REER to re-examine the relationship

between the exchange rate and trade, and find that the industry-specific REER index performs

better than the traditional aggregate REER index. We recommend that the Chinese Government

officially adopt industry-specific exchange rates instead of using the aggregate effective

exchange rates to evaluate the competitiveness of Chinese industries in the international

market.

Key words: China, industry, real effective exchange rate, trade

JEL codes: F14, F31, O24

I. Introduction

Over the past decade, there has been considerable debate regarding the effect of the RMB

exchange rate on the Chinese economy. Most researchers adopt the country-level aggregate

real effective exchange rate (REER) to analyze related issues (Shu and Su, 2009; Sun, 2009) .

However, as price evolution and trade patterns vary across industries, a more accurate

* Mi Dai, Assistant Professor, School of Economics and Business Administration, Beijing Normal University,

Beijing, China. Email: daimi002@gmail.com; Jianwei Xu (corresponding author), Assistant Professor,

School of Economics and Business Administration, Beijing Normal University, Beijing, China. Email:

jwxu@bnu.edu.cn. This paper is supported by the Fundamental Research Funds for the Central Universities

(No. 2012WYB34) from Beijing Normal University. The authors are grateful for the helpful comments

from Kiyotaka Sato, Junko Shimizu, Nagendra Shrestha, Bin Zhang, Qiyuan Xu and other participants in

the seminar “Establishing Surveillance Indicators for Monetary Cooperation between China and Japan” held by

the Institute of World Economics and Politics, Chinese Academy of Social Science, 26–28 October 2012, Beijing.

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Industry-specific Real Effective Exchange Rate for China

©2013 Institute of World Economics and Politics, Chinese Academy of Social Sciences

evaluation of the effect of the exchange rate on industry performance should be based on the

REER related to the relevant industry-specific pattern. In other words, when evaluating the

performance or competitiveness of a certain industry, measuring aggregate REER at the country

level will, in most cases, be misleading because the heterogeneous characteristics of each

industry are disregarded, potentially leading to unreliable results. This is the “aggregation bias”

problem.

While there are clear advantages of using industry-specific REER in terms of both

economic implications and research applications, few studies have applied such an index,

with research particularly lacking in developing countries, such as China. Most international

organizations, including the IMF, the Bank of International Settlements (BIS) and the OECD,

only release aggregate REER data. Gourinchas (1999) analyzes the effect of the exchange

rate on wages and, to the best of our knowledge, is the first to use industry-specific REER

in such an analysis. Subsequently, in empirical studies, Campa and Goldberg (2001) and

Klein et al. (2003) emphasize the importance of disaggregated REER. Goldberg (2004) uses

industry-specific trade data for the USA to construct industry-specific REER for 20 different

industries. However, these studies only distinguish industry-specific characteristics through

industry trade data and ignore the importance of price differences among industries. For

example, Goldberg’s (2004) calculation applies the same aggregate consumer price index

(CPI) to every industry in each country, leading to an inaccurate measurement of industry

competitiveness.

Lee and Yi (2005) find that trade differences alone are not sufficient to accurately

estimate industry-specific REER, as price changes could be completely different in each

sector, especially when exchange rate pass-through varies substantially across sectors. To

solve this problem, they adopt the industry-specific producer price index (PPI) in place of

aggregate CPI to estimate industry-specific REER in Korea, and find that the differences in

price indices are the major causes of the differences in industry-specific REER. A related

study is the calculation of industry-specific REER for Japan by Kiyotaka et al. (2012). They

suggest using more high-frequency (even daily) data to calculate an REER.

Imbs et al. (2005a,b) and Fazio et al. (2007) adopt industry-specific data to measure the

mean conversion speed of purchasing power parity (PPP). They find that the heterogeneous

effect of price deviation from the law of one price could be an important solution to the PPP

puzzle. Kehoe and Midrigan (2007) examine the relationship between price stickiness and

exchange rate fluctuations through the industry-specific real exchange rate. Applying the

industry-specific real exchange rate is widely regarded as an important direction for future

research.

The present paper proposes a measure of disaggregate REER for China by considering

both industry-specific prices and industry-specific trade patterns. This is the first paper to