Sources of Fluctuations in US-China Bilateral Real Exchange Rate: Evidence from A Structural VAR Model

This paper examines the dynamic evolution of the US-China bilateral real exchange rate using monthly data over 1990-2007. We develop a structural VAR model using a mixture of short run and long run restrictions and study the impacts of various structural shocks, both US and China, on the bilateral real exchange rate. We have obtained several interesting findings. First, the US-China bilateral real exchange rate can be explained more by the exchange rate shock than the supply or demand shocks from either economy, nor by the oil shock. In addition, the exchange rate does not seem to be the problem of any country\u27s economy as the industrial production does not seem to respond to the exchange rate shock or have the exchange rate shock as a main explanatory factor. The real cause of the imbalance problem must lie somewhere else. Second, individual country shocks do not seem to influence the other economy significantly. Each country\u27s output and consumer price are mainly explained by its own domestic factors rather than shocks from the other. For China, this finding may endorse China\u27s recent move toward more flexibility in its exchange rate relative to the US dollar. Third, we find that the US consumer price responds to China\u27s aggregate supply shock and believe that the oil price may play a part in it, but the explanatory power is low