Rural-led exchange rate appreciation in China

•China has too much labor in rural nontradables.•When rural labor leaves, the supply of nontradables falls.•When labor is efficiently allocated, demand for all goods rises.•If the supply of nontradables falls and the demand rises, the price rises.•This price is the real exchange rate, so rural emigration causes appreciation.

The departure of a factor in excess supply in a non-traded rural sector leads to a Rural-led Exchange Rate Real Appreciation (RERA), in a dual economy setup. The RERA highlights for the first time a potential link between intra-national factor movements and real exchange rates. In China, where there is excess labor employed in the production of (largely) non-traded rural goods, we attribute around one third of the recent appreciation of the real exchange rate - defined as the relative price of nontradables - to a RERA effect.

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