Currency manipulation in China?
A common argument in the west is that the culprit of global imbalances is the exchange rate manipulation carried out by the Chinese authorities. The manipulation thesis rests on the simple idea that the imbalance itself is evidence of a misalignment of the exchange rate. Letting market forces determine the exchange rate would, according to this view, restore trade balance.
Unfortunately, the proponents of this view do neither spell out explicitly the mechanism of their claim nor do they provide much evidence corroborating it. The question is: how could China possibly maintain a severely misaligned real exchange rate for more than a decade, without feeding domestic inflation pressure, e.g., by increasing the demand of non-traded goods and stimulating domestic wage pressure?
As a comparison, when many European countries repeatedly devalued their currencies in the 1980, the only effect remaining two-three years after the devaluation was an increased inflation. The fact that China’s standard of living increased at a staggering pace during this period amplifies the puzzle: one would expect that as people get richer, they consume a larger share of non-traded goods, and this should feed into domestic wage growth.
This subproject aims at taking the currency-underevaluation thesis seriously by modelling such manipulation explicitly and studying how its theoretical predictions matches up with the empirical evidence for China.