Relevant international experience of real exchange rate adjustment for China

Is the real appreciation of the Chinese yuan essential for correcting global imbalances? The present study offers a new perspective to the debate by drawing upon the rich international experience embodied in World Bank's World Development Indicators database. We find that the price levels of China and the United States are both low relative to the world's average. Therefore, the discrepancy between the price levels of China and the United States has been, in fact, close to zero since 2002. The difference in per capita income can fully account for the price difference between China and the United States. However, the Balassa-Samuelson effect is not a reliable guide for projecting the trend of real appreciation. According to the experience of those economies that have experienced real currency appreciation against the US dollar in 1985-2005, the mode of faster wage growth and inflation is as common as nominal appreciation, far more common for economies with a low initial price level. We do not find empirical evidence to substantiate the claim that low price levels tend to cause external surpluses. But real appreciation has a powerful effect in boosting job creation in the service sector. Therefore, the real appreciation of the Chinese yuan would contribute to restructuring the Chinese economy towards a domestic demand-based growth track.